Selective Amnesia at the Bank of Canada
A guest blog from Marc Lavoie and Mario Seccareccia, Department of Economics, University of Ottawa
Â In a speech delivered on October 4th to the Winnipeg Chamber of Commerce (see: http://www.bankofcanada.ca/2012/10/speeches/a-measure-of-work/), the senior deputy governor of the Bank of Canada, Tiff Macklen, has offered some self-congratulatory remarks, by arguing that the near-zero inflation policy pursued by the Bank under the leadership of John Crow had given rise to a healthy and more efficient labour market, with low unemployment rates. Senior deputy Governor Macklem has only one regret: labour productivity growth in Canada has been dismal for a long time, despite low inflation rates, a feature that he finds puzzling.
The senior deputy governor is clearly suffering from selective amnesia. His former bosses, Governors John Crow and Gordon Thiessen, used to argue that low inflation rates would generate high rates of productivity growth. These claims were based on what was supposedly solid econometric research being conducted at the Bank of Canada in the 1980s and the early 1990s, notably by Jack Selody, which concluded that inflation was the single most important variable in explaining the slow or negative productivity growth witnessed since the early 1970s. When slow productivity growth continued in the 1990s and 2000s, despite low and stable inflation rates, it seems puzzling that no one at the Bank thought it worthwhile to reconsider the empirical evidence and question the Bankâ€™s mantra that the best that it can do is to keep inflation low. Indeed, there may well be a third factor that could explain the low productivity growth rate and that, rather than enhancing productivity growth, their current policy could actually be exacerbating this serious problem facing the Canadian economy.
Senior deputy governor Macklem blames businesses for not having invested enough in machinery and technology, and Canadians for not being educated enough and for a lack of investment in their human capital. While these may well be problems plaguing the Canadian economy, perhaps he should also look at the near zero-inflation austerity policies long pursued by the Bank of Canada, as well as the unwillingness of the Bank to stop the Canadian dollar from appreciating. This is because Canada is suffering from not one but perhaps even two â€œDutch diseasesâ€. Despite the partial denial of its significance by Governor Mark Carney, the first one is well-known and has recently been the topic of heated debate among politicians that has pitted the eastern and the western regions of this country. There is some evidence to suggest that, because of the high price of oil and natural gas, and the resulting huge foreign investment flows going into the tar sands in Alberta, the Canadian dollar has over-appreciated. The high Canadian dollar has contributed to the decimation of our manufacturing industry, which is the sector most likely to benefit from productivity enhancements, by making our manufacturing firms less competitive on world markets, as happened in the Netherlands in the 1960s as a result of the discovery of North Sea oil.
But there is a second type of â€œDutch diseaseâ€, one also associated with low productivity growth and low rates of unemployment, the latter sometimes having also been called ironically the â€œDutch miracleâ€. When unions, employers and the government agreed to wage moderation in exchange for jobs in the 1980s, Dutch rates of unemployment fell to really low levels, both in absolute terms and relative to those of their neighbours, and this feature of the Dutch labour market is still largely the case today. However, the low nominal and real wage increases generated low domestic economic growth, and led to a vicious cycle of low consumption spending and low productivity growth. This paradox can be explained by the simple fact that little pressure for real wage growth combined with weak aggregate demand led to a redistribution of income towards profits, and induced very slow labour productivity growth. Hence, the combined phenomena of low real wage growth and anaemic aggregate demand is a recipe for low productivity growth, which in the economics literature is often described as Verdoornâ€™s Law, justly named after a famous postwar Dutch economist. It can be said that a similar phenomenon has occurred in Canada: the monetary austerity policies conducted by the Bank of Canada over several decades to achieve and maintain near-zero inflation rates have been associated with a low long-term growth environment sometimes plagued by recessions as in the early 1980s and 1990s. These relatively low average growth rates and relative high unemployment (when compared, say, to those of the first few decades of the postwar period) have completely weakened the power of labour unions, leading to de facto wage moderation. The slow increase in real wages, tied to slow output growth, as had occurred in the Netherlands, has generated the slow productivity growth that seems to puzzle so much the senior deputy governor. In fact, it is the combination of this lacklustre output growth compensated by even weaker productivity growth, which has permitted unemployment rates not to rise as much, thereby permitting the senior deputy governor to celebrate the success of the Bank of Canada policy of achieving low inflation rates. In our opinion, however, this is a Pyrrhic victory.
The Great Moderation in wage and price inflation has not delivered the goods that officials at the Bank of Canada had promised since the 1980s. Mr Macklem claims that low inflation has provided Canadians with economic and financial welfare. But what is the evidence of that? We have an economy in which real wages have stagnated and a relative standard of living that is in relative decline when compared even to our closest partner the United States, whose productivity growth had been significantly higher than ours until the financial crisis. Contrary to what they had long claimed at the Bank of Canada, low inflation has delivered neither solid economic growth nor strong productivity growth. If unemployment rates had improved since the early 1990s and until the financial crisis, this is because, on average, producing a good or service in Canada still requires almost as many hours of work as it did some years back! This is hardly a reason to celebrate. Moreover, unemployment rates are still far above from what they were during the first three decades of the postwar period when our economy was delivering a virtuous cycle of growing real wages, rising productivity and a moderate inflation rate. Clearly, the Bank needs some new economic thinking.