A boom in the labor market may prevent a slowdown from becoming a recession

Teff McClem, Governor of the Bank of Canada, at the Globe and Mail Center on September 10, 2020.Fred Lom/The Globe and Mail

When Bank of Canada Governor Teff McClem faces the media this Wednesday after what is sure to be another sharp rate hike, reporters will surely ask him some version of “Do you expect a recession?” or “Are you trying to engineer a recession?”

Mr. McClem’s answer would be “no.”

But would he and his colleagues be upset if their sharp increases in interest rates led to a quarter or two of a contraction in demand for goods, services, and even labor? of course not. This is the goal of raising prices.

“But hey, isn’t that a slump?” The scream comes from the cheap seats.

Well, no, actually, it isn’t.

The distinction is more than semantics. It defines the exact line the central bank is trying to walk.

The issue of the Canadian recession reached new heights last week, when the economics team at the Royal Bank of Canada became the first to formally predict a “recession” — albeit “mild and short-lived by historical standards.” More specifically, the bank expects GDP to contract by 2 percent. 0.5% in both the second and third quarters of 2023.

It has identified raising interest rates in the Bank of Canada as the primary catalyst for this deflation.

“High interest rates will technically push Canada into deflation,” RBC said in a report last Thursday — while acknowledging that the central bank “has little choice” if it is to dampen the serious threat posed by inflation.

First, it is noticeable that RBC is out here; Economists at the rest of the country’s banks do not expect an outright drop in GDP by one quarter, let alone two in a row. But what RBC describes as a “moderate recession” is arguably not a recession at all.

Yes, it fits with the loose definition of a recession that hasn’t been particularly helpful, and which many economic watchers have embraced in an armchair: two consecutive quarters of decline in GDP. (You will sometimes see a standard of two consecutive quarters referred to as “technical slack.” In fact, this is probably the least technical of all the definitions. It is technically wrong.)

Usually, a decline in GDP is only one indicator. For the economy to be in a true recession, there is a lot that has to go wrong. What economists are looking for is evidence of a continuing decline in activity across the entire economy.

The National Bureau of Economic Research, which has long been the official arbiter of what constitutes and does not constitute a recession in the United States, is looking at a range of additional indicators — including employment, real income, industrial production, and wholesale and retail sales — to determine whether a contraction in GDP constitutes a recession. . In Canada, the CD Howe Institute’s Business Cycle Committee takes a similar broad approach to calling recessions.

It is fair to say that, among these criteria, contraction in the labor market is pivotal. You can’t have a real recession if employment remains strong.

The US economy may have just gone through exactly this kind of thing: a two-quarter GDP contraction (the first quarter of 2022 and, according to some estimates, the second quarter) was not accompanied by a stagnation in employment. Avery Shenfield, chief economist at the Canadian Imperial Bank of Commerce, described it as a “non-franchise”.

“The definition of a recession by itself essentially excludes a person without a job loss,” Shenfield said in a research note last week.

Which brings us back to the situation in which the Canadian economy found itself, and where the Bank of Canada has room to maneuver.

There is no doubt that the Canadian labor market has been suffering from a historical imbalance of supply (not enough) and demand (too much). The unemployment rate is at its lowest level in half a century. The country had nearly a million vacancies in the first quarter of this year, more than 70 percent more than pre-pandemic levels.

These numbers suggest that you can remove quite a bit of demand before tipping the scales the other way. Even in RBC’s “recession” scenario, the bank sees the unemployment rate rise to 6.6 percent — a rate that “would not be much higher than full-employment levels in the long run,” the bank acknowledges. This seems like a fairly balanced job market. Hardly the kind of hardships associated with the last depression.

It is not just about labor if there is an increase in demand in this country; The Bank of Canada said in the spring that a “broad range of measures” showed the economy was operating beyond capacity. This indicates that an economic slowdown is possible that will only bring the demand for labour, goods and services back into equilibrium with supply.

This is the needle the Bank of Canada is trying to thread. It won’t be easy. Rapid interest rate increases have pushed overheated economies into recession before, and they could have done it again.

But with so much excess demand, especially in the labor market, we are still far from that tipping point. In our current case, a bit of an economic correction doesn’t lead to a recession, not in the way we usually think.

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