Quantitative Tightening

Senior deputy governor Carolyn Rogers, insists that the cause of inflation is “excess consumer spending.” The Bank of Canada is formally independent from cabinet, but Deputy Prime Minister Chrystia Freeland has explained how the raising of interest rates helped to shape the government’s program cuts.

“I know that my fiscal prudence surprised many in this room,” Freeland told the Empire Club. “Yes, I do read your predictions. This fiscal restraint was very intentional. At a time when inflation was elevated, we knew we needed to be careful not to increase aggregate demand.”

In March 2020, when Canada began its descent into the deepest recession in its history, nearly $700 billion in corporate bailout money was prepared by the federal government. All told, the emergency funds, which saw support for businesses far outpace support for unemployed workers, drove the federal deficit above $100 billion.

At the same time, the Bank of Canada cut its interest rate to 0.25 percent and initiated, in the governor’s words, “large-scale purchases” of bonds “to help restore market functioning and then to bolster our monetary policy stimulus,” pushing the central bank’s balance sheet to $575 billion. The aim, as the Financial Post notes, was to “flood the system with money.”

Since that time, even if it is now contracting, Canada’s economy has seen a relative expansion. Corporate profit margins recovered too, rising by one count from an average of 9 percent from 2002 to 2019 to 16 percent in 2021. Since the first quarter of 2020, Statistics Canada data suggests that aggregate corporate profits continued to increase substantially, at least into the second quarter of 2022.

Long-stagnant average hourly wages, although rising 2.7 percent from 2019 to 2021 in absolute terms, have actually fallen as a share of GDP. Meanwhile, inflation has risen steadily, further fueled by supply chain crises. In response to these worsening difficulties, regulators and, it would seem, the Cabinet of Canada, has looked to make workers and the poor bear the brunt of the inflation.

Making Workers Pay

In spite of these complexities, in a speech to the Canadian Federation of Independent Businesses, Macklem called for workers to accept real wage cuts and for Canada’s bosses to actively resist wage increases to match inflation. According to Macklem, such wage increases create “a self-perpetuating cycle.” “As businesses,” he said, “don’t build that into longer-term contracts. Don’t build that into wage contracts. It is going to take some time, but you can be confident that inflation will come down.”

While effectively asking bosses to impose wage cuts, the governor further hinted that higher interest rates and, presumably, spiking unemployment is on the central bank’s agenda. Just three years ago, the central bank boasted that Canada’s economy was marked by low wage growth owing to “labor market reforms designed to increase labor market flexibility.” In a naked display of where its priorities lie, it is now suggesting that the road out of inflation requires new wage cuts and more precarity for workers. But the argument put forward by Macklem — the risk of a “wage-price spiral” — is not new.

While wages and inflation may rise at the same time, even the empirical link between wage increases and price hikes is questionable. One of the Bank of Canada’s own simulations, for example, found that a 0.7 percent change in  minimum wages causes fairly minor 0.1 percent increases in general prices — assuming that all other following wage contracts adjust upward.

Furthermore, average wage growth does not match the current price increases. In June, the Parliamentary Budget Office noted that wages have risen 8.6 percent since the onset of the pandemic, while inflation has risen 9 percent and continues to rise. “To date, wage settlements data also show little indication of higher observed and expected inflation feeding into wage negotiations in the unionized sector.” The report found that, rather than broad “demand increases,” it is “constrained supply — along with surging energy and food prices” that has led the spike in inflation.

What About the Profit-Price Spiral?

In some sectors of the economy, like durable manufacturing, real wages have been cut because of microchip shortages and production shutdowns. However, these sectors have not cut prices as a result. In the United States, as economist Judge Glock noted for the Wall Street Journal:

Wages are what economists call “sticky,” meaning they don’t change as fast as other prices do. When inflation comes along, gasoline stations can switch their price signs in an hour and restaurants can adjust their menus in a day, but most employees get a salary bump only once a year.

According to popular narrative, firms may want to “pass-off” wage increases to customers with price hikes. But the “spiral” is more complicated than the explanation offered in this account. Raising prices diminishes firms’ ability to sell. This generally acts as a disincentive to produce — unless the firm is a monopoly of some sort, insulated from competition.

Moreover, as a recent survey by Canada’s fast food lobby Restaurants Canada notes, workers are not paid the full value of their output — otherwise there would be little to no profit. In the food service industry “labor costs” consume around 30 percent of total sales. According to economist Jim Stanford, this insight generally applies to other sectors across Canada. “Labor costs make up only one-third of direct production costs, on average, across all industries.” It is these same industries that have seen their “already-swollen” profit grow.

As one landmark 2019 European Central Bank study noted, the relationship between “labor cost” increases and price increases is not guaranteed. Rather, the nature of the “spiral” varies according to variables such as “international competition,” “workers’ turnover rates,” “capital intensity,” and other related trends. This is all to say that bosses raise prices to secure their bottom lines — wages do not force their hand. Accordingly, wage increases are not automatically “passed off” or translated into price hikes — they simply cut into profits.

Curiously, corporate profits are unmentioned by the Bank of Canada, which has not denounced a “profit-price-spiral.” Nor has it insisted that corporate gougers and monopolists need to be reined in. This is because, in the eyes of Canada’s bosses, regulators, and business-friendly journalists, profits are inviolable rights while wage growth is almost always excessive.

Back in 2013, as Canada emerged from its last significant recession, then Bank of Canada governor, Mark Carney,  insisted that “an effective currency union” required, among other things, “downward flexibility” in wages — especially “during uncertain and volatile times.”

“It is impossible to escape the frustration and stress that inflation brings — especially for those living on lower or fixed incomes,” Rogers said recently — shortly before insisting another shock is in order. “Workers are looking at the rate of inflation and what it’s doing to their purchasing power, their budgets, and they’re looking at the same tight labor markets and they’re thinking, you know, I need a raise. This is also completely understandable,” she said. Nevertheless, she insisted, rates must rise and, presumably, so must unemployment.

It is hard to tell how high interest rates will go and how deep the next recession will be, but it is clear that business will be bailed out at the end. And, as usual, workers will be pushed to bear the brunt of the cost.