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Scotiabank economist Laura Gu is back to break down even more common and not-so-common economic terms you might be hearing in the news. We’re talking curves, yields, spreads, even Goldilocks. All in an effort to help you better understand the world of finance. Or just impress your friends.
Looking for another vocabulary-expanding economic primer? Check out 11 economic terms to better understand the news.
Key moments this episode:
1:07 — Term 1: Labour market
2:48 — Term 2: Phillips curve
3:58 — Term 3: Yield curve
6:41 — Term 4: Credit spreads
7:22 — Term 5: Secular stagnation
9:40 — Lightning round and term 6: Goldilocks economy
9:56 — Term 7: The overnight rate
10:24 — Terms 8, 9, 10, 11 and 12: Recession shapes — V-shaped, U-shaped, W-shaped, L-shaped and K-shaped
11:18 — Term 13: No landing
11:52 — Term 14: Immaculate disinflation
Stephen Meurice: A few months back we had Scotiabank economist Laura Gu on the show to break down some common and not-so-common economic terms we might be hearing in the news. And we had such an edutaining time that we thought, ‘Hey why not do it again?’ So, this week we’ve rounded up another fresh batch of economic terms for Laura to define. We’re talking curves, yields, spreads, even Goldilocks. All in an effort to help you better understand the world of finance. Or just impress your friends. I’m Stephen Meurice and this is Perspectives.
Laura, welcome back. Great to see you again.
Laura Gu: Thank you. It's great to be here.
SM: You did such an amazing job last time defining economic terms that we decided to do it again.
SM: This time. We have yet another amazing prize for you. Ready for the taking. Are you ready to go?
LG: Wow. Yeah, I'm very ready.
SM: Okay, so just to recap, we're going to run through a list of economic terms and you're going to help us understand each one of them. Then there's a lightning round, of course. And if you put up with me for that long, you certainly deserve the prize. Are you ready?
LG: Yes, I am.
SM: Okay. The first term we're going to ask you about today is labour market, which sounds kind of simple. But, as with everything economics, is probably more complicated than I know.
LG: You're right. I love talking about the labour market. It refers to the interaction of workers and employers where you know, workers provide the supply for labour and employers decide the demand for labour. Though right now the labour market is very tight, which means there are plenty of job openings but not enough available workers. We call it labour market tightness, which is normally a state of the labour market with low unemployment and higher wage growth, which is also very inflationary. The opposite of that would be the labour market slack, which means there is a gap between the actual level of employment in an economy and what it could potentially be. And it shows how much the workforce is either unemployed or underemployed, meaning the individuals that are employed are either not fully utilizing their skills or working in jobs that are below their qualifications. When there is a lot of labour market slack, it can indicate that an economy is struggling, resulting in low productivity and income, low living standard and increasing inequality as well.
SM: Okay, if I have this right, the labour market is all of those factors that play together on the demand side, on the supply side, affected by the general state of the economy, either tightness or slackness, meaning there's more demand for workers or less demand for workers. That's what we would call the labour market, all of those things.
LG: Yes, you got it. A labour market is a good indication if an economy is healthy and it's not as simple as how it sounds like.
SM: Right. All right. Next one. This one doesn't sound simple at all. What's a Phillips curve?
LG: A Phillips curve is a way to think of the trade-off between unemployment and inflation. So basically the curve suggests that when unemployment goes down, inflation goes up, and when unemployment goes up, inflation goes down. The idea is based on the fact that when there are more people employed and can afford goods and services, prices for things go up. And this happens when the economy is doing well and everyone's working. And when businesses need more workers, they pay higher wages. And to make up for these higher wages, they charge more for the products and vice versa. When there are more people without jobs, prices can go down.
LG: So you plot unemployment rate against inflation and when you have higher unemployment rate, you have lower inflation and you have lower unemployment, you have higher inflation. But over the years, there has been a flattening of the Phillips curve, meaning that inflation remains subdued even when unemployment kept dropping to really low levels. And there has been a lot of debates in terms of the accuracy of the Phillips curve.
SM: Okay. So our next term, we have another curve for you. This is the yield curve. And I know I've heard that sometimes especially people talk about an inverted yield curve. Maybe you can explain those things.
LG: Yes, absolutely. So first of all, what is yield? Basically, a bond’s yield is a return an investor expects to receive is year over its term to maturity. And the yield curve shows the relationship between the bond yields and bond maturity.
SM: And traditionally longer-term bonds would have a higher rate of return?
LG: Yes, that would be a normal yield curve. So when you look at the graph of bond yields, even though this at the longer term bonds usually have higher yields than the shorter term ones. And this is because investors are taking on more risk when they lend their money for a longer period of time. To compensate for this risk, investors demand a higher yield on longer term bonds. And this is why, you know, a normal yield curve is upward sloping as yields rise, along with the length of maturity. And a normal curve is typically seen during times when the economy is expected to grow at a normal pace without any major disruptions. However, there are times when the curves shape changes. This could signal some potential problems in the economy.
SM: So when they talk about an inverted yield curve, that means that the yields on short term bonds are higher than the yields on longer term bonds.
LG: That's right. The yield curve inverts when the yield on shorter term bonds, it's higher than the yield on longer term bonds. And this happens when investors are pessimistic about the future direction of the economy and believe that interest rates will be lower in the future than they are today.
SM: Right. So when people like you see that inverted yield curve, that's a warning sign that bad times may be ahead. Is it always the case?
LG: In history, yes. Most of the cases, that is a good indicator for a major slowdown.
SM: Right. And we have an inverted yield curve now.
LG: Yes, we do.
SM: Okay. So the yield curve is the difference between the yield or the return, I guess, that investors can expect between short term and long term bonds. Traditionally, it goes up so that longer term bonds have a higher yield. But when investors are worried about the near future, that relationship tends to flip the other way. And short term bonds have higher yields than long term bonds.
LG: Exactly. You're doing great.
SM: Okay. All right. Maybe I should get the prize.
SM: All right. Our next term is credit spreads.
LG: Okay, a credit spread is essentially the difference in yield between a corporate bond and a risk-free treasury bond of the same maturity. Credit spreads are used to gauge market risk. Essentially, a credit spread represents the premium that investors demand for holding lower rated or riskier bonds compared to less risky bonds.
SM: Okay, so credit spreads, that's the difference between the yield or the return on corporate bonds versus safe bonds, like the type of bonds that governments put out.
LG: Yes, essentially.
SM: All right. The final term is secular stagnation.
LG: Yep. Remember last time we talked about stagflation and unlike stagflation, which is kind of a doomsday term, secular stagnation refers to a prolonged period of slow economic growth, persistently high unemployment, low inflation, despite the stimulative monetary and fiscal policies that aims to boost economic growth. And secular stagnation is often described as a situation where there is too much savings available but not enough investment opportunities and not enough demand for goods or services, which could lead to a prolonged period of slow economic growth or even economic contraction. As we know, the lack of demand for goods and services can lead to lower employment, lower wages, reduced economic activity overall.
SM: Right. So unlike a recession which can come and go, it lasts some period of time and then it goes away and growth starts up again. When you have secular stagnation, it's become sort of systemic in your economy and things slow down over the longer term.
LG: Yes, I like the way you put it, that’s a good way to interpret it.
SM: Okay. There's been talk in Canada for a long time about bad or low productivity growth. Would you say we are in a period of secular stagnation?
LG: Yes, low productivity growth here in Canada is definitely a major issue that needs to be addressed. Especially once we get past this inflationary episode that’s ongoing. So there's a high chance that we might see a return of secular stagnation once we get past, you know, the current high inflation episode. And it's generally agreed that advanced economies have been facing a relatively low growth environment since the great financial crisis.
SM: All right. Now, Laura, it's time for The Lightning Round. We're going to rifle through a big batch of economic terms as quickly as possible. And of course, legally, we can't do a lightning round without dramatic music. Producer Andrew, if you please.
[dramatic music begins]
SM: Now remember, a huge prize up for grabs here, one that we're going to give you regardless of the outcome, because we're all winners when it comes to economic education.
LG: Sounds good.
SM: Are you ready?
LG: Yes, I am.
SM: All right, let's go. Goldilocks economy.
LG: A Goldilocks economy, it’s an economy that is not too hot or cold. An economy that’s just right. It is generally characterized by moderate to high economic growth, low unemployment and stable inflation.
SM: Okay. The overnight rate.
LG: Overnight rate is the rate used on the overnight market. The Canadian financial institutions transfer funds daily for their customers. And at the end of each day, they reconcile these payments by borrowing from each other in the overnight market with a target interest rate set by the central bank. And also impacts other interest rates in the economy, such as the prime rate of commercial banks, which determines the rates of mortgages and line of credit.
SM: All right. Next one, different recession shapes.
LG: So they're pretty self-explanatory. I don't know if I will see all of them in my lifetime. Stephen, you probably have.
LG: So let's start with a V-shape recession, which is a sharp decline in economic activity, followed by a quick and strong recovery. And a U-shaped recession, it is a more gradual decline in economic activity, followed by an even more gradual recovery. And the W-shaped recession, it's sort of a double dip recession. L-shaped recession is a situation where the economy experiences a severe and prolonged downturn, resulting in a long period of little or no growth. And also a new term, a k-shaped recession, which has different parts of the economy experience divergent outcomes during a downturn. The COVID-19 economic contraction was a classic example of that.
SM: No landing.
LG: No landing is kind of a buzzword in the media these days. This is neither a hard landing nor a soft landing. And the hard landing is recessionary scenario. A soft landing refers to when a central bank successfully lowers inflation to target without causing a recession. And the definition of no landing, it refers to when economic growth doesn’t slow down, unemployment remains low and inflation stays above trend. And some argues that there is no such thing called no landing, since the economy needs to land eventually at some point, either hard or soft.
SM: And our last one of the lightning round: immaculate disinflation.
LG: Immaculate disinflation refers to a scenario where the central bank is able to effectively control inflation through rate hikes with minimal damage to economic growth and employment.
[dramatic music ends]
SM: Well, Laura, you did it again. And as promised, we have a prize for you. Andrew, tell her what she's won.
Andrew Norton: Stephen, Laura will never miss an upcoming monetary policy report with this brand new, equine-themed day planner! It’s pocket-sized, has a section for notes and each month features a striking new image of a horse or horses. Congrats, Laura.
LG: Wow, I love it. Thank you, guys. It's a horsey.
SM: Laura, thanks so much for coming back. It's always a blast to have you on the show. Really appreciate you coming.
LG: Thank you.
SM: I've been speaking with Laura Gu, Economist at Scotiabank. If you liked what you heard today, be sure to check out the other “economic words” episode we did with Laura a couple months ago. You can find that in our feed, and we’ll link to it in the description and story page. The Perspectives podcast is made by me Stephen Meurice, Armina Ligaya and our producer Andrew Norton, who only pitches episodes that involve him visiting the dollar store.