Bank of Canada calls out lack of productivity

BANK OF CANADA PHOTO

Carolyn Rogers is the Bank of Canada’s Senior Deputy Governor. She said in a recent speech that a healthy economy depends on high productivity.

Did the Bank of Canada just throw the government under the bus?

That was a question from a colleague after the central bank’s No. 2 official – Carolyn Rogers – gave a speech on Tuesday calling attention to Canada’s awful productivity numbers.

Some saw it as a criticism of Prime Minister Justin Trudeau’s economic record, which may be why this one speech received such a large reaction from the media and politicians. (Speeches and reports on Canada’s falling productivity haven’t been exactly sparse).

Why did this speech get so much attention? Perhaps the language used by Rogers to describe the situation was more candid than typical from the Bank of Canada.

At a time when the governing Liberals are being widely panned for their record, this statement from Rogers is a provocative one: “You’ve seen those signs that say, ‘In emergency, break glass.’ Well, it’s time to break the glass.”

And it’s getting the Trudeau critics all riled up. See this post on X from Saskatchewan Premier Scott Moe.

The central bank, led by the very technocratic Tiff Macklem, wasn’t trying to wade into politics. So what message was it trying to convey?

With the economy struggling under the weight of higher rates, the central bank is under a lot of pressure from politicians and the public to cut borrowing costs quickly. And Macklem probably will start cutting soon, as early as June. But before then, he wants to keep expectations at bay until he sees even more evidence that inflation has been brought under control.

Enter productivity. Canada’s falling productivity means the economy can’t grow very fast without triggering inflation. In a low productivity economy, businesses are less able to absorb higher costs, and they are more likely to pass on these costs to consumers. Thus higher inflation.

And because of the higher inflation threat, interest rates need to remain higher than would have otherwise been the case had our productivity record been stronger. Rogers’ comments are simply a hawkish statement about future policy settings.

Still, markets and economists are pricing in about a percentage point of rate cuts this year, and another half point in cuts early next year. So, over the next year or so, we can see a full 1.5 percentage cut in rates. That would bring the policy rate to about 3.5 per cent, and prime rates offered by commercial banks to just under six per cent.

BANK OF CANADA PHOTO

The economy is on track to grow by an annualized pace of 3.5 per cent. This will give Bank of Canada Governor Tiff Macklem, pictured, pause as he considers what the pat to rate cuts will look like.

Stubbornly strong GDP

Despite the higher rates and weak productivity, however, Canada’s economy continues to soldier on. This is both good news - we all want stronger growth - but also a complicating factor for the Bank of Canada.

Monthly estimates for GDP released on Thursday by Statistics Canada showed the economy is on track to grow by an annualized pace of 3.5 per cent in the first quarter of this year. This is well above the Bank of Canada’s estimate for growth of 0.5 per cent for that period.

This represents a significant acceleration from the second half of last year when Canada’s economic growth came to a standstill, and will give Governor Tiff Macklem pause as he considers what the path to rate cuts will look like.

One possibility is that the numbers reflect one-off factors, such as an unseasonably warm winter and the return to work by striking Quebec public sector workers. But the GDP figures make the likelihood of a rate cut before June much less likely.

Unwelcome population volatility

The Bank of Canada’s reluctance to fully embrace the case for aggressive rate hikes also reflects, in part, continued difficulties in getting a solid reading on the economy - which has been a feature of the post-pandemic world.

This week’s warning by the Bank of Canada on productivity was also a bit of a mea culpa by the central bank. The Bank had been predicting a much stronger productivity landscape, which hasn’t materialized.

Uncertainty remains the order of the day for the nation’s economic picture, making it tough to assess the outlook with much conviction.

Some of this uncertainty is self-inflicted.

Take the swings in international migration flows that we’ve seen over the past couple of years. Population numbers are usually slow moving, steady variables driven by long-term demographics that most economists take for granted. No longer!

Labour supply has now become a volatile macroeconomic variable, not unlike business investment, that is making it extremely difficult for economists to understand exactly what is going on. And the more economists are uncertain about the projections, the more likely that policy makers will be cautious about making decisions. For example, when and how to proceed with rate cuts.

Immigration Minister Marc Miller announced on March 21 the government will lower the number of temporary residents in the country by (more or less) a half a million, from current levels of just under 2.7 million.

If the government follows through, the impact will be to bring population growth in absolute terms to between 300,000 and 400,000 per year over that span. This is less than one-third the pace of population growth in 2023 (1.3 million) and less than half the increase in 2022 (930,000).  As a rate of growth, Canada’s population will increase by between 0.7 per cent and one per cent, below long-term historic averages of about 1.2 per cent.

The end result of this sort of dramatic swing in population numbers is tough to predict. It will almost certainly be a drag on economic growth, but its impact on inflationary pressures and the Bank of Canada is more ambiguous.

The move by the government (if it happens) will help ease pressure on housing and rent inflation by curbing demand - which should theoretically give Canada’s central bank more scope to cut rates.

But capping the labour supply also undermines the nation’s capacity to produce goods and services. Like falling productivity, slowing labour supply growth threatens to stoke inflation.