Job Gains Don’t Signal a Need for More Rate Hikes

Canadian Economics

This op-ed by Pedro Antunes was originally published in The Toronto Star on January 19, 2023.

Last week, Statistics Canada released another solid jobs report. Despite the Bank of Canada’s push on the brake pedal, Canada’s economy created 176,000 jobs over the last four months of 2022, and started this year with an additional 150,000 jobs in January, with those employed topping the 20 million mark for the first time. Solid employment gains, especially in full-time and private sector roles, as has been the case in recent months, is generally perceived as good news.

However, commentaries that followed the announcement took it as bad news, suggesting that the Bank of Canada has not raised rates sufficiently to slow economic growth and inflationary pressures. But the opposite is true—strong employment gains are just the ticket our economy needs to quell inflationary pressures.

Canada’s Employment Tops 20 Million

(employment; 000s)

2019 2020 2021 2022 2023 16,000 16,500 17,000 17,500 18,000 18,500 19,000 19,500 20,000

Source: Statistics Canada.

To understand why job creation is good at this stage, we need to understand how both supply and demand changes can impact inflation. The surge in inflation in Canada (and globally) in the past two years demonstrates the interplay of these factors. Demand was buttressed by generous support measures like the CERB and cheap credit, while remote work resulted in a surge in demand for housing and household furnishings. We couldn’t spend on travel, dining out or other services so we spent on cars, camping gear, and mountain bikes. The surge in spending on these types of durable goods far outpaced “normal” levels—suppliers couldn’t keep up to the increase in demand and prices soared.

The pandemic also caused a dearth in supply of some goods. COVID-related production shutdowns contributed to inflationary pressures, particularly in the first year of the pandemic. Also, negative oil prices in 2020 were certainly a disincentive to drilling; oil production fell sharply during the pandemic and was slow to recover when the economy reopened. Other commodities followed similar patterns, while food prices were driven up because of weather-related production problems. And then came Russia’s invasion of Ukraine, which delivered an additional massive blow to global commodity prices.

These factors drove up inflation in 2021 and 2022, many of which were seen as temporary by the world’s central banks. They weren’t wrong on most fronts: oil production would catch up to supply (as it has); spending on mountain bikes would ease as consumer spending normalized (we can now travel and go to restaurants); and supply chain snags are letting up. The risks of further inflationary shocks, due to the spread of COVID in China, or a further escalation of Russia’s war, remain. But inflationary pressures clearly eased in the second half of 2022.

By raising rates, the Bank of Canada has sought to address three key sources of domestic inflationary pressure that are less temporary in nature:

  • First, the unexpected persistence of temporary inflation effects has raised inflation expectations among businesses and consumers.
  • Second, pandemic related reductions in immigration caused the labour market to tighten much faster than expected.
  • Finally, the surge in house prices during the pandemic is now having wider implications on rents and other prices.

Higher rates are proving effective at addressing the sources of inflation that are demand driven. For example, retail sales growth has flattened, and home prices have declined. The reason employment is still rising is that there remains excess demand for workers across many sectors of the economy. And a significant pickup in immigration and inflow of non-permanent residents throughout 2022 is now helping to fill that void—addressing the supply shortage not by beating back demand, but by adding to supply.

Supply chains bottlenecks are easing, demand is normalizing, most commodity prices are back down to pre-war levels, and the added supply of workers will help bolster our capacity in those areas where demand is still hot and take pressure of wages.

In effect, we’re addressing inflation in two ways, by easing demand through higher rates and by adding to supply with employment gains. It’s a win-win that will help soften the bite of this economic slowdown. The situation should keep inflation going in the right direction, without the need for further rate hikes.