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(BLAIR GABLE/REUTERS)
(BLAIR GABLE/REUTERS)

Bank of Canada needs to chill on inflation Add to ...

Bill Currie, the Deloitte managing director for the Americas, is out on the conference circuit, trumpeting his views on why the productivity gap between the U.S. and Canada has kept increasing by pointing to the reluctance of Canadian businesses to invest in growth. Lack of productivity growth is also a big concern of the Bank of Canada. Just last week, the Bank’s senior deputy governor, Tiff Macklem, delivered a speech asking why productivity growth has stalled for so long, despite low unemployment rates and a stable low-inflation environment for years prior to the financial crisis.

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They have good reasons to be concerned. Bank officials used to argue that low inflation rates would generate high rates of productivity growth. These claims were based on econometric research conducted at the Bank of Canada in the 1980s and early 1990s which concluded that inflation was the single most important variable in explaining slow or negative productivity growth. When slow productivity growth continued in the 1990s and 2000s, despite low and stable inflation rates, it was time to review the empirical evidence and question the Bank’s mantra that the best it can do is to keep inflation low.

Like Mr. Currie, Mr. Macklem blames businesses for under-investing in machinery and technology. In addition, he blames Canadians for not investing enough in education. But other causes for slow productivity growth include the policies now pursued by the Bank of Canada: near-zero inflation in the climate of austerity, and an unwillingness to stop the Canadian dollar from appreciating.

There is some evidence that Canada is suffering from not one but two “Dutch diseases.” The first one is well-known and has recently been the topic of hot political debate: rising prices of oil and natural gas have led to massive financial flows into the tar sands. The Canadian dollar has overshot and that has contributed to the decimation of our manufacturing industry, making it less competitive on world markets, as happened in the Netherlands in the 1960s.

There is, however, a second Dutch disease, one associated with low productivity growth and low rates of unemployment, the latter having been called by some the Dutch,orPolder, miracle. When unions, employers and the government agreed to wage moderation in exchange for jobs in the 1980s, Dutch rates of unemployment fell to quite low levels, both in absolute terms and relative to those of their neighbours, as is still the case. However, the slow increases in nominal and real wages, combined with weak aggregate consumer demand, ultimately slowed down productivity growth.

A similar phenomenon has happened in Canada: the monetary policies conducted by the Bank of Canada to reduce inflation then maintain it at near-zero rates led to two deep recessions during the early 1980s and 1990s, which significantly weakened the power of labour unions, leading to de facto wage moderation. The sluggish increase in real wages, tied to anaemic output growth, as occurred in the Netherlands, has generated the slow productivity growth that so puzzles central bank officials.

Thus the Great Moderation in wage and price inflation has not delivered the goods that officials at the Bank of Canada had promised. Low inflation has delivered neither solid economic growth nor strong productivity growth. If unemployment rates have improved since the early 1990s and until the financial crisis, this is because, on average, producing a good or service in Canada still requires almost as many hours of work as it did some years back. This is hardly a reason to celebrate. Unemployment rates are still above what they were during the first three decades of the postwar period when our economy was delivering a virtuous cycle of growing real wages, rising productivity and a moderate inflation rate. Clearly, the Bank needs some new economic thinking.

Marc Lavoie and Mario Seccareccia are full professors in the Department of Economics at the University of Ottawa

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