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Inflation remains stubbornly high and Canadians are increasingly feeling the pinch in grocery stores, at the gas pumps, restaurants and more.
The Bank of Canada has raised interest rates to tame it, but Scotiabank’s Chief Economist Jean-François Perrault says the central bank should not be in this battle against inflation alone.
In this episode, Perrault is our guest and he breaks down his latest economic report on how Canada’s federal government can help make a dent.
Key moments this episode:
1:14 – Perrault's summary
2:45 – What impact could the federal government make on inflation?
6:23 – What kind of government spending are we talking about?
7:58 – Why the government providing money to individuals may actually make the inflation problem worse
Stephen Meurice: By the time you’re listening to this, StatCan will have announced the inflation numbers for May. And they’re expected to be pretty grim.
Canadians haven’t seen inflation like this in decades. And it’s not going away anytime soon.
Responsibility for fighting inflation largely falls to the Bank of Canada. And the Bank’s main weapon for doing that is increasing interest rates.
But what if there was something the federal government could do as well, not just the Bank of Canada, to get control of skyrocketing prices.
That’s the premise of a recent article co-authored by Jean-François Perrault, Scotiabank’s Chief Economist.
And he’s here today to explain why the Bank of Canada shouldn’t be the only inflation fighter.
I’m Stephen Meurice and this is Perspectives.
JF, welcome back to the show. Judging by your voice, this isn't your first interview in the last 24 hours.
JFP: Thanks, Steve. [laughs] It certainly isn't.
SM: OK, how about this? We’ll courier some lozenges to your house.
JFP: OK, that works. They'll be more expensive, though because inflation is high.
SM: [laughs] You're the king of the segues, JF. So we brought you in again today to talk about an article that you just published. That you co-wrote with one of your colleagues on the economics team at Scotiabank. And I won't bother trying to do any kind of summary. I'll just let you, can you give us the one paragraph summary of the point that you're making in this article?
JFP: Yeah. So, at the heart of it, it’s a pretty simple argument. It's simply to say, listen, inflation is incredibly high in Canada. The government and the Bank of Canada have a joint responsibility, a joint understanding that they're gonna work together to bring inflation down to 2%. That's kind of part of the Bank of Canada's mandate. So our argument is simply, listen, given how exceptionally strong inflation is, they're probably are benefits to the Government of Canada working more closely with the Bank of Canada to achieve its inflation mandate. And one way to articulate that is if the government were to reduce its spending profile a little bit, that would allow the Bank of Canada to raise interest rates, probably a little bit less then otherwise it would need to and therefore lessen the adjustment burden on the part of the private sector. Because the government sector would be taking some of that adjustment burden on. So, it's just basically the benefits of coordination and protecting the private side of the economy, perhaps a little bit more than we would if the government were to leave the Bank of Canada to basically do what historically it's done, which is manage inflation.
SM: Right. So, let's break that down a little bit. The Bank of Canada's mandate, among other things, is to manage inflation. They have a range that they try to stick to. Currently, inflation is well above that range and looks to be staying up there for some time. The bank’s main tool for trying to control inflation is to increase interest rates, which they've been doing at a fairly aggressive pace and are expected to continue. But what you're saying is that maybe the federal government has a more active role to play. So far, it's been the Bank of Canada doing most of the work. The federal government may have a more active role to play in that. Can you go into that a little bit? What you're talking about them and reducing their own spending? What difference would that make?
JFP: Yeah. So, I mean, think of it the way the Bank of Canada would think about it, which is when they raise interest rates, they're doing that because it changes economic activity, it reduces economic activity, that reduction in economic activity ultimately impacts inflation.
So the key is bringing economic activity down. And when the Bank raises interest rates, the adjustment on economic activity occurs on the private side. But you can have a situation where government spending falls and you get a reduction in economic activity because government spending is lower. And to get back to basics on that, you have to think about how we calculate GDP in Canada. So, one of the ways in which you calculate GDP is you add consumption , investment government spending, you add exports, you take away imports and there's inventories in there. So, you can play with that ‘g’ is what we call an economics and bring that down. That brings economic activity down, it reduces inflationary pressure. And makes the Bank of Canada’s job a little bit easier. So, you know, there's basically a linear path. The more you cut government expenditures, the lower economic activity is and therefore less inflationary pressure you have.
SM: How big is the federal government's share of GDP? Their spending. How much of GDP does that make up?
JFP: It's pretty big. I don't have the exact numbers, but you know, we figure that if government spending at the national level basically only rose by something like 2% in the next couple of years. So, it's not like it's a huge adjustment, but if it rose by about 2% next couple of years, that would be enough to shave about 75 basis points off what we think the Bank of Canada is currently on track to do. So, we think they're gonna raise the 3%. If they were to keep expenditure increases to about 2, 2.5% in the next couple of years that allow the Bank of Canada rate to peak at around two and a quarter.
SM: As opposed to 3?
SM: Wow. So that's a that's a significant difference between those two levels of interest rate that they that they might hit. How significant would it be for the federal government to hit that level of spending? Cause you're still talking about growth in spending of 2%. What are they projecting?
JFP: So, this so this is at the national level and of course, the federal government is one of the layers of government. So, there's federal, provincial, municipal. The bulk of spending is actually done by provinces and municipalities. So, it actually requires a fair amount of effort on the federal side, you know maybe something like flat expenditures next couple of years. And of course, in an environment where wages are rising rapidly and an environment where the price of goods services rising rapidly, because you know they're buying stuff just as we are. It would require some sacrifices. Like this is a difficult political challenge. If they were to take it you'd have to either constrain the wage bill to be flat, which in the current environment is obviously a big challenge for workers, right? You're effectively asking them to take a real pay cut. Or you reduce the number of workers. And again. You know, if anybody's been traveling the last little while you've known you go to an airport, you try to get your passport renewed. You try to access some government services. They're clearly aren't [laughs] enough workers attached to those tasks. Now, that doesn't mean that you need to hire workers. Maybe you can shift workers around. But it's not like there is necessarily all these workers you can get rid of very easily with no impact on the lives of Canadians. So going down this path requires a fair amount of political courage, and because it is going to impact Canadians. I mean governments provide services that we benefit from to large degree.
SM: But the levels of spending have increased significantly over the last couple of years during the pandemic. Is it even conceivable that the government could get back to levels of spending similar to what they were pre pandemic and would that achieve what you're what you're talking about?
JFP: Yeah. So it's not exactly the right type of comparison. So, when we think about government spending in the context of the work that we've done, it's really, you know it's GDP entry called government consumption. It's basically wages and salaries and goods and services that they purchased. So, it's not program spending, it's not the wage subsidy, it's not an employment insurance, it's not healthcare. Those are transfers and some of them go to individuals and some of them go to provinces. You can reduce the wage bill without touching program spending in some circumstances. So, you don't you don't affect the programs, you don't affect the services that we that we are provided with. But you reduce the number of people that you have, that are involved in the delivery of those services.
SM: OK, so if I understand correctly, by reducing the amount of money the government spends on buying stuff and paying people. That reduces some of the demand pressures that exist within the economy and therefore help contribute to slowing inflation, reducing demand.
JFP: That's exactly right.
SM: So, we're not talking about government programs. We’re talking about the things that the government spends money on in the normal course of their operations. You've mentioned already the political challenges around doing something like that. The amount of political courage it would take. [laughs] Is it possible?
JFP: The political instinct here is to help Canadians, of course, right? Inflation is a problem. Like nobody likes inflation and it's eroding our purchasing power. It's making it more difficult for households to manage their finances. This is not a good thing. So, one way for governments to help is to provide households with a bit of a financial offset of some sort. So you got provincial governments that are doing this for instance. Like giving cheques for $500 to individuals to help with the cost of living increase. That's a very tangible way in which governments can provide assistance to households. The problem with that approach, as appealing as it is politically and as helpful as it is to those people that are getting it. By providing more money to individuals now, you're actually making the inflation problem worse to some extent. The purpose of the note was to try and highlight that to some extent. That you know, the politically appealing solution to helping reduce the cost of living actually makes the cost of living problem worse for those that aren't getting that amount of assistance. So, the ultimate solution is effectively to lower economic and the government's got a good lever there that they can choose to use if they want to, which is reducing their own consumption expenditures.
SM: OK. So can I ask, you talked about some of those programs about provincial governments and I guess maybe arguably the federal government is doing the Finance Minister talked about some money that I guess was in the budget. She said it's not new money and so on, but it is transfers that are not currently happening, that would happen, that would go to individuals. So, in your view then like those types of things, like they're helping individual Canadians deal with the problem of inflation, but they're actually exacerbating the problem overall?
JFP: Yeah. And that's the really tricky part of it. You know, think of childcare. As wonderful as cheaper childcare is, more affordable childcare is, and we really do think this is enlightened policy, strongly support what the government is doing on that front. But when you got an economy that's in excess demand, it needs to slow, cutting the cost of childcare for families gives them more money to spend elsewhere. And you can argue to some extent it effectively makes the inflation problem worse. Now we still think it's worth doing because childcare is really important, but those are some of the consequences of these actions, right? So, you might have put in place a policy two years ago to increase, you know, assistance to renters. And that just happens to come into effect this year. Well, when you designed that policy two years ago, you didn't have an inflation problem. You got an inflation problem now. So those are coming in to help at the right time, miraculously well timed. But it's, at the margin, it's making the inflation outlook a little bit worse.
SM: So, you're trying to think of other approaches that might help on the flip side to counteract some of that?
JFP: Exactly. It raises challenging questions and difficult questions and at the end of the day these are political, right? The economics are pretty clear. It's a matter of what is politically acceptable.
SM: Well, JF thanks for being on as always. We love to hear you even when we have trouble hearing you.
JFP: You're very welcome. Thanks, Steve.
SM: I've been speaking with Jean-François Perrault, he is the Chief Economist at Scotiabank.
JF recently co-authored an article with René Lalonde, Director of Modelling and Forecasting at Scotiabank called, Why is the Bank of Canada Fighting Inflation Alone? We’ll put a link to that in the show notes as well as the story for this episode at scotiabank.com/perspectives