Former Bank of Canada governor Stephen Poloz sees coming period of stagflation

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Former Bank of Canada governor Stephen Poloz said that Canada is heading into a period of slowing growth and high inflation known as “stagflation” – although he said that this won’t necessarily last long nor result in an outright recession.

Speaking on a podcast published by the C.D. Howe Institute on Friday, the former top central banker said the global commodity price shock resulting from Russia’s invasion of Ukraine will likely lead to an economic slowdown in Canada alongside higher consumer prices.

“The rise in commodity prices and food prices across the board are sucking income out of everybody’s pockets. They’ve lost money for all the other sectors of the economy, so there will be a slowdown in the domestic economy as a result of that,” Mr. Poloz said.

This will be partially offset by Canadian energy companies, miners and farmers, who benefit from higher commodity prices. But Mr. Poloz noted that high oil prices are unlikely to spur as much investment in Canada’s energy sector as in past commodity cycles, “given the uncertainties about the longer-term future” of the oil industry.

In the face of a commodity price shock, the Bank of Canada can either move interest rates higher in a measured way – allowing inflation to come down gradually while the economy slows – or to slam on the brakes by raising interest rates quickly to restrictively high levels.

“Stagflation is actually, to be honest, the preferred outcome,” Mr. Poloz said, arguing that the sweet spot is a short period of “technical stagflation” where growth slows a moderate amount, not “the kind roaring stagflation like we had in the seventies.”

“If instead you raise interest rates really fast to prevent any inflation from affecting the Canadian economy, well you’d be forcing a disinflation shock through the rest of the economy, probably with a major slowdown, or even a recession. Well that would be nonsense,” he said.

The Bank of Canada’s policy interest rate is currently at 1 per cent. Central bank officials have said they intend to raise the benchmark rate relatively quickly to a “neutral range” of between 2 per cent and 3 per cent. They have signalled that another half-percentage-point rate hike is likely at the beginning of June.

Former central bank governor David Dodge, who appeared on the podcast alongside Mr. Poloz, said that any coming stagflation would look quite different than it did in the 1970s, when the rate of inflation hit double-digits and unemployment topped 8 per cent.

“Yes there is a danger that we’ll have inflation on an ongoing basis a bit above perhaps the 2-per-cent target that we had been used to, but we’re not in the same position as we were in the seventies,” Mr. Dodge said.

This echoed a speech by Bank of Canada deputy governor Toni Gravelle last week, where he argued that structural differences in the economy makes a rerun of the 1970s unlikely. Employment contracts are less likely to be indexed to inflation today, reducing the chance a wage-price spiral will develop. People’s expectations for future inflation are also better anchored than in the 1970s as a result of the several decades of low and stable inflation.

In his speech, Mr. Gravelle differed from Mr. Poloz in his assessment of the likelihood of a period of stagflation, noting the current strength of the economy and record low levels of unemployment.

“Given where we are now, we don’t see the stagnant part of stagflation – quite the opposite,” Mr. Gravelle said.

Both Mr. Poloz and Mr. Dodge said on the podcast that the bank should get its policy rate back into the 2-per-cent to 3-per-cent neutral range relatively quickly. Although Mr. Poloz said the bank will need to pay close attention to incoming economic signals to ensure it doesn’t trip the economy into a recession.

“There’s a lot more household debt out there,” he said. “The sensitivity of the economy, both on the corporate and household side, is perhaps higher to a given change of interest rates than before, so that makes for more uncertainty to what that neutral rate might be.

“It’s like landing a plane in the fog: You know when you hit the runway that you’re there. But right up until that moment, you’re trying to be data dependent.”

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