Welcome to Canada, Where You Ignore Policy Lags at Your Own Risk

Earlier this month at an IMF conference celebrating the contribution of Ken Rogoff to international economics, the scholar argued that one would need to go back to the 1970s to find a time period as “extraordinarily difficult” as the current one. It is “extraordinarily difficult” to argue otherwise.

Just this year in Canada, forecasters like us have navigated through a litany of shocks, from the federal employee strike and the Vancouver port strike to ice storms and wildfires. As we yearn for a more tranquil end to the year, Quebec’s Front commun representing a total of 420,000 workers in the health care, social service and educational sectors initiated a strike early this week. It was later joined by teachers and nurses, swelling the ranks to nearly 600,000.

Absent an agreement, the Front commun threatens an unlimited general strike. Such a large group—9% of Quebec’s workforce—engaging in an extended strike would result in a significant dent to hours worked and GDP. That would stem not only from the direct impact of striking workers, but also the indirect impact, as many parents—particularly mothers, as we saw during the pandemic—may be compelled to take time off work to look after their children. The magnitude of the stakes argues for a swift resolution. But if one fails to materialize, the strike will add to the long list of disruptions in 2023 that have made the economic context extraordinarily difficult to make sense of.

More hopeful news came from BoC governor Tiff Macklem this week. We hadn’t heard such a clear signal that the hiking cycle might be over in quite some time. This declaration came on the heels of the encouraging October inflation report (which may not have been so encouraging for those looking for a place to rent). And it came despite a fall economic statement that showed larger projected deficits External link. This link will open in a new window., reflecting the recent drumbeat of initiatives on industrial subsidies and homebuilding.

However, the key question was always the extent to which the government spending profile was different from what the Bank had assumed less than a month ago in its Monetary Policy Report. We can infer that there wasn’t enough of a discrepancy in the eyes of Tiff Macklem for him to hold back on offering a more dovish signal. And it probably doesn’t hurt that the 17% jump in borrowing for this fiscal year alone coincides with the BoC’s accelerated balance sheet reduction to put a floor under bond yields and keep financial conditions tight.

What a difference six weeks make! In early October, markets were pricing in a first rate cut no sooner than 2025, a stance we argued severely misjudged the BoC’s likely rate trajectory. The stickiness of inflation and the underappreciation of long and variable policy lags led some to jump on the higher-for-longer bandwagon in Canada. Now that excess demand has vanished, growth is stagnant, the job market is loosening and inflation continues its descent External link. This link will open in a new window., the short-sightedness of that perspective becomes even more apparent.

As we’ve stressed, the Bank of Canada undertook one of the most severe monetary policy tightening cycles from a starting point of record-high household debt and some of the most leveraged consumers in the advanced world (graph). So far, we have seen a clear impact on consumer spending and housing activity.

But heading into 2024, we should be alert for potential knock-on effects on wealth. We are seeing Canadian home listings creep up while the GTA is slipping deeper into buyer’s territory External link. This link will open in a new window., with Vancouver not far behind. This underscores the risk of a new leg of price declines. Consumer spending is already retrenching, especially on a per capita basis. But just think about the prospects if we also have to contend with a negative wealth effect in housing, which makes up about half of Canadian middle-class household wealth. Our conditions for rate cuts External link. This link will open in a new window. would be met in no time. And a soft landing would become just about as improbable as the return of the Quebec Nordiques.