Governments must work to eliminate their deficits or the upward pressure on interest rates will intensify, writes Philip Cross in the Financial Post. Below is an excerpt from the article, which can be read in full here.
By Philip Cross, November 26, 2021
Inflation is proving to be more than transitory, reaching an 18-year high of 4.7 per cent last month. Government-created distortions of personal incomes, savings and labour market choices are helping fuel it. These distortions also make inflation harder to forecast, although economists have long struggled to develop a viable theory that forecasts inflation. As a result, many central banks have been slow to react to the price rises. At a fundamental level, inflation reflects our collective inability to agree on how to pay for the massive debts incurred during the pandemic.
Policy-makers assumed the pandemic’s major effect was greater for demand than supply. The disruption to supply surprised the Bank of Canada, which in summer 2020 predicted “much of the initial decline in supply is likely to be relatively short-lived.” Central bankers are now hedging their forecasts, however. Bank of Canada Governor Tiff Macklem recently acknowledged price increases were more than temporary, partly because the Bank has downgraded its estimate of potential economic growth nearly a full point to 1.6 per cent. For his part, Fed Chair Jerome Powell has admitted that “Supply-side constraints have gotten worse. The risks are clearly now to longer and more persistent bottlenecks, and thus to higher inflation.”
The government’s most striking distortion was to provide so much emergency income support that personal disposable incomes actually rose in a recession. Earned income fell sharply but massive government support more than made up the difference. The increases in incomes and savings show that much government aid was not needed, especially during the slow shift from economy-wide stimulus to targeting specific sectors. The government response also distorted the labour market, resulting in the unusual pattern of high unemployment combined with high job vacancies.