Lessons learned might be helpful in unwinding of ultra-low interest rates
The world is still in shock over inflation’s rise, writes Peter Hall. Photo by Darryl Dyck/The Canadian Press Is forecasting a lost art? Prominent pundits go further than this, suggesting it’s a lost science, that the models are broken. Expressions like, “It’s different this time,” or the classic, “It’s a new normal,” underline a general feeling among analytical elites that our persistently chaotic times have rendered future-gazing nigh unto impossible.
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Make no mistake, this admission of failure is no surrender; the forecasting industry is alive and well, and will be for as long as can be, well, predicted. Why? Inaccuracy does not recuse us from the task. Predictions, from the entry-level buyer of raw inputs to seasoned professional prognosticators and everyone in between, are essential to the flow of business, the maintenance of a household and the management of government policy.
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In this light, what do we make of the sudden onset of inflation?
A quick reminder as to how sudden that was: In February of 2021, annual CPI inflation was just 1.2 per cent, and disinflation was still a concern. Fast-forward five months, and it had more than doubled, to four per cent. Against soothing assurances that this was temporary, by year-end it was 5.5 per cent, and only intermittently saw monthly declines while surging to 8.1 per cent in June. After decades of control, in a flash we were zapped back to the 1970s.
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We’re not the only ones; the same general pattern occurred in the United States, where CPI inflation peaked at 9.1 per cent in June. Ditto for the European Union, which initially resisted monetary tightening and now faces annual consumer price increases of 9.9 per cent and rising. True, these increases were greatly impacted by the more volatile prices of food and energy. However, netting those out, so-called core prices are still well out of central banks’ comfort zones, and until recently were generally going in the wrong direction.
The world is still in shock. But with the exception of an inflation-scare moment in mid-2008, Canada has enjoyed over 30 years of prices that have barely budged from the target point of two per cent. How could so many have been so fooled by so much?
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First, hysteresis. That’s a fancy word that roughly means that what existed for so long is expected to always be, regardless of conditions. Second, messaging. Pundits everywhere were gloomy about recovery prospects, and had an army of world leaders and policymakers convinced that soaring unemployment and sluggish demand would stanch price and wage inflation for years to come. Oops. Why was it so readily believed? Possibly due to a third factor: recent history. The only true economic downturn many of today’s decision-makers have lived through is the global economic crisis of 2008-09. Ergo, cut and paste the long, drawn-out recovery to this one. Oops again.
Gotta hand it to Yogi, he’s still right: “It’s tough to make predictions, especially about the future.” That was his way of saying that hindsight is 20/20. It’s easy to pounce on an obvious predictive miss, and to most, beyond a primitive desire to lay blame, it’s pretty useless. Unless, that is, we can learn from the episode. Are there lessons?
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It would seem so. It’s now clear that regardless of the length of a regime, inflation or otherwise, things can turn on a dime. Nothing can be taken for granted. We should also note that regardless of how esteemed the spokesperson, they can be dead wrong. Not a few widely respected pundits have gone down in flames over one bad call.
Recommended from Editorial Canadians’ outlook on their finances, economy went from dark to darker last month, poll shows Ottawa aims to balance fiscal restraint with targeted support amid darkening economic outlook Aggressive Bank of Canada rate hikes expected to put more strain on Ottawa’s finances Bank of Canada is walking a fine line, but rates will go higher, says Tiff Macklem A third lesson is perhaps more encompassing: no single economic downturn is exactly like another. A key mistake was to equate the 2020 economic collapse with its immediate predecessor. In a few key ways, it was nothing like 2008-09. This one didn’t happen to us; it was a policy decision. A second, related feature is that this one was not preceded by a multi-year bubble of globalized irrational exuberance. In fact, it was quite the opposite; a period of under-performance in the world’s engine economies had quietly given rise to a groundswell of pent-up demand — enough economic oomph to last a good few years. And that was added to by a pan-planet surge of mid-pandemic savings. This is likely why the policy decision to restart the economy created one of global history’s most dramatic, instant V-shaped recoveries on record. There was nothing wrong with demand; supply simply couldn’t keep up.
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Article content If correct, this final lesson could be very helpful — to business strategy, policymaking, and even household planning. If it turns out that the world’s ‘driver economies’ are fundamentally strong, then rising interest rates are not essentially bubble-bursters; they are accommodating sustainable growth, and the move toward more ‘neutral’ rates is — at long last — a key sign of a return to normal. It also means that slamming demand to restore overall balance might not be wise. Efforts might be better spent in restoring those supply chain logjams that are truly temporary, and ferreting out the transitory opportunism that always accompanies a sudden rise in prices. It also implies that easing back on fiscal stimulus might not be as painful as feared.
Without a doubt, the unwinding of ultra-low rates will not be painless. But if it occurs in tandem with other possible private and public actions, fundamentals suggest it might just achieve its stated aims, and be a lot less painful than most currently believe.
Peter Hall is CEO and chief economist at Econosphere Inc. and former chief economist at Export Development Canada.