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Past holds lessons in living with long-haul economic disruption

The 1970s and 1980s have much to teach us about tackling inflation now
The upward spike in Metro Vancouver gasoline prices at the pump is another symptom of 2022 inflation.

New generations of Canadians  have never known runaway inflation or its cure: prohibitively high interest and mortgage rates.

As any baby boomer will tell you, it’s not pretty.

There are worrying signs that today’s inflation is not as transitory as central bankers and economists were forecasting, partly because those forecasts were made before Russia invaded Ukraine, which has compounded an energy crisis in Europe, adding to oil price inflation.

“I’m increasingly worried that this unexpected surge in inflation that we saw play out last year, and which has actually gained additional momentum in 2022, is going to become entrenched,” said Jock Finlayson, economist and senior policy adviser for the Business Council of BC (BCBC).

“It’s the biggest economic risk we’ve got by far at the moment. Policymakers on both sides of the border have let this inflation get out of control, in my view.”

The Canadian economy is currently firing on all cylinders, with GDP growth almost keeping pace with inflation. But if there is an economic contraction, leading to higher unemployment, during a period of inflation, stagflation can set in.

Unlike a recession, which typically lasts six to 18 months before the economy reboots, inflation and stagflation can be more persistent.

“Those episodes can last for years,” Finlayson said.

Some of the conditions that set the stage for the inflation and stagflation that peaked in the early 1980s are also present now. Then and now, the world experienced a global energy crisis that sent oil prices soaring, which increased the cost of almost everything. But the West is less energy intensive than it was in the 1970s and 1980s, Finlayson noted, and, whereas the U.S. was heavily reliant on the Middle East for oil imports in the 1970s and 1980s, the U.S. (and Canada) is more energy self-sufficient now.

“We’re not as dependent and as sensitive to energy prices today as we were in the ’70s and ’80s,” Finlayson said.

One other key difference is that the current period of inflation was partly triggered by supply chain shocks as a consequence of the global pandemic and subsequent lockdowns – something that should eventually get sorted out.

“We are anticipating that there will be some moderation of these supply chain issues that we’ve been grappling with over the last couple of years as we progress through 2022 and 2023,” said Marc Desormeaux, commodities analyst for Scotiabank (TSX:BNS).

Inflation is currently at 8.5 per cent in the U.S. and around 6.7 per cent in Canada – about half the inflation rate in 1981. Canada experienced a decade of high inflation, starting at five per cent in 1972 and peaking at 12.5 per cent in 1981.

By 1983, it had dropped to 5.8 per cent, but the hammer blows used to get it there was crushingly high interest rates and a deep, prolonged recession.

“Inflation rates on both sides of the Canada-U.S. border are disturbingly close to those that prevailed during the last period of stagflation in the ’70s and ’80s,” the Business Development Bank of Canada warns.

In order to temper the runaway inflation that followed two oil crises in the 1970s, central banks raised interest rates to as high as 18 per cent in Canada and 20 per cent in the U.S.

Canadians experienced a decade of high mortgage rates that led to defaults and prevented many first-time homebuyers from becoming homeowners. High interest rates also raised the cost for governments in servicing their debts.

“When you talk about the generational memory of inflation in the ’70s and ’80s, that’s what people remember most vividly: the incredible march-up in borrowing costs,” Finlayson said.

But no one is expecting central banks to resort to those kinds of interest rate hikes ever again.

The Bank of Canada recently raised the benchmark interest rate to one per cent and is expected to continue with several more hikes.

“We’re anticipating that Bank of Canada will get up to 2.5 per cent by the end of this year and then to three per cent by the end of next year,” Desormeaux said. “We think at this stage that will help to cool inflation and get us back to the targets eventually.

“When we look at where real rates are in Canada and the U.S. right now, they are still very stimulative relative to history, and even after the projected rate hikes that we have built into the next couple of years, they’re still expected to be stimulative.”

But while central banks are now moving to try to temper inflation with rising interest rates, the Trudeau government continues public spending at a rate that some economists argue is not needed and, therefore, inflationary.

The Canadian economy is experiencing strong GDP growth – 4.6 per cent in 2021 – and a record low unemployment rate. Flooding an economy that is already heating up with more public spending may only fuel inflation, Finlayson and others warn.

William Robson, CEO of the C.D. Howe Institute, likens it to keeping one foot on the economy’s accelerator while banks are tapping the brakes.

“Monetary tightening and fiscal excess prefigure a wild economic ride ahead,” he recently warned. “Perhaps a recession.”

“I would say we have macro-economic incoherence,” Finlayson said. “We have governments that want to spend and borrow, but we have an economy where we actually don’t need that. We need more fiscal restraint than we’re likely to get.”