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.
As always, this is a great piece.
One of the truly unfortunate side-effects of central bank independence here in Canada is the mistaken belief that no politician is permitted to criticize the CB. In Canada, as soon as a politician utters a word about monetary policy, the media and pundits interpret the statement as an affront to the doctrine of CB independence. A nonsensical delusion that goes against the very meaning of democratic governance.
In many ways, this piece reminds us that the CB and the government that gives it its span of control should be accountable for the decisions it makes and the justifications given to support these decisions in the past.
Linking weak productivity growth to monetary policy is crucial, especially given the hysterics in recent years on the impact of the aging population. Rational observers understand that there is no future demographic catastrophe with decent productivity growth. Considering the role of the CB in helping to improve productivity growth is only normal. Pointing out the failings of current policy is essential.
I believe increasing the inflation target to 3 or 3.5 percent would go a long way in improving the economy. Recall that during the early post-war period, inflation averaged around 4 percent. Blanchard at the IMF, Krugman and many others seem to agree that a higher target might be beneficial to economies.
Marc and Mario, I would be interested to know what you think the CB or government could do to help improve productivity growth?
Isn’t the Bank of Canada just getting the correlation between productivity and inflation backwards: that higher productivity tends to reduce inflation, rather than low inflation tends to create higher productivity?
I would rename this blog- Murderers of the Canadian Economy- Death Blows by the Ignorant BOC Hammers and the perpetual state of 1% pain for the working class.
One follow up point- the Oil sands does not have to be a point of divide, but the Harperites want it to play out that way- working with the Albert Federation of LAbour a couple weeks back, points to a solution for the tar sands that I think is a great compromise for all.
Slow the development of the tar sands, and instead build more value adding capacity in the province for the existing massive flows of the bitumen. More refineries and higher value adding jobs. Truly- once the construction caused by the expansion ramps down, the permanent jobs in the tar sands will be scaled back. So why not build more value adding capacity here in Alberta and elsewhere?
It truly is the win win for everybody, as that would settle the dollar down on a trajectory to long run PPP and allow the management of the dollar distortion of our commodity currency that over values the dollar and makes everything Canadian produced and serviced less competitive in the global economy.
Firstly, on the question of what can the government do to increase productivity: It is obvious that as economies have become mostly serviced-oriented the possibilities of increasing productivity growth have been shown to be more limited historically (as we have emphasized in Baumol, Blinder, Lavoie, Seccareccia 2010, Microeconomics, Chapter 15). Moreover, in a country like ours that seems to be moving away from manufacturing and returning back to an Innesian world where we are becoming progressively once again a primary resource staple producer for the rest of the world, we should recognize that this latter sector faces to some extent Ricardian diminishing returns. Hence for those two reasons, we cannot expect anything but chronically low productivity growth over time. What is needed is increasing investment not as much in the resource-based activities, like the oil sands, but more so private investment in manufacturing, which presently seems to be highly unlikely. Moreover, as I have emphasized, in a paper that was presented at an INET conference in April 2011 at Bretton Woods and which is currently published in the winter 2011-12 issue of the International Journal of Political Economy, we ought to be engaged in much greater public investment that tends to be quite complementary with private investment and whose effect would also be to enhance somewhat productivity growth. This ought to be both a short-term policy to provide further stimulus through deficit spending in times of recession so as to benefit from some of the effects of Verdoornâ€™s law but also as a long-term public investment commitment to sustain growth in productivity in an otherwise increasingly-oriented service economy over time. Secondly, I completely agree with Paul Tulloch that increased manufacturing value added even in the oil sector should be promoted rather supporting a pipeline to the Gulf of Mexico or the BC coast as the Harper government has been pushing for! But the latter would be the in the realm of what would be a good industrial policy with benefitial externalities in terms of good jobs and productivity growth.
Nastily for the plutocrats, evidence is piling up from many, many sources that the key question economically is “who gets the money”. When the share of the wealth going to “profits”, “capital”, “landowners”, “rentiers”, “shareholders” or “CEOs” (depending on what you’re looking at) increases, within a decade or so it starts to act as a consistent drag on the economy. When the share of the wealth going to wages and generally to the “average person” increases, the economy starts to boom.
Too, too consistent to be an accideent.
Paul: Well, win-win for everybody except the foreign owners of much of the oil patch.
Mr. Seccareccia: I think the rise of the “service economy” has been vastly exaggerated. Much of the “shrinkage” of manufacturing is more a matter of “relocation”. I don’t think China has a service-dominated economy. And much of the money value of the “service economy” is basically parasitic–collecting rents on the main economy by creating illusionary money from leverage which spends like the normal kind.
@plg, yes that is the point, win for Alberta and win for the rest of Canada. Friend wealth will have to live with our sovereign decisions. Profits are still garunteed , but more investment will be needed. It’s not like we are going to nationalizrpe it, and if these interests are willing to make similar investments in countries that are more likely to nationalize, then I am sure they will complain, but it will be mild.
Sorry that should be foreign wealth, Freudian slip by my iPad spell corrector, lol friend wealth!
“Friend wealth” is a great name to call them. It removes capital from the center of the economy, without denying thier usefulness.
Here is a thought- I wonder how successful an overvalued dollar economy will feel to Harper and crew when the corporate income statements start bleeding a whole lot more red than what occured in the post crash slump era- 09-’12 – a period where nothing really of much happened in Canada accept a furthering of the pressures to keep our dollar high and kill off any chance of investment in our value adding infrastructure where the home office of the branch plant economies sat on their piles of cash- waiting – and consumers continued their indebtedness downward dance – merrily further and further to the bottom of the rabbit hole, where tea parties were the leading forum for crusaders of economic mismanagement (murderers of the economy)
Follow the white rabbit Mr. Harper- where high oil prices keep our dollar 6 feet high and rising (isn’t that a Johny Cash song?) and more resource extraction is heralded where somehow small province of Alberta is stripped naked of its future (and its landscape) in a mere 10 years of massively expanded bitumen extraction, and instead of building permanent high value adding jobs that process and develop the bitumen, sit on the sidelines happy as beavers to build the bitumen superhighways to steal away their assets, under the banner of progress, and wealth- (sadly profit extraction for foreign multinationals.) This all in the name of destroying two of the largest provinces who rely their export value adding economies with a dollar denominated at a catch 22 cents above PPP- and over 60 percent of the population riding on those two economies health.
My question is- how does Harper get away with- and I do not mean in Canada, as I think he will not as the army of discontent is building outside of the western provinces- but how does he get away with this in Alberta?? I do think the Nexon takeover is just the beginning of the end of Harper’s- pull the wool over his home territories eyes. How can Alberta survive without Oil? or a value adding infrastructure to process that oil. One day- affordable oil from tarsands will be gone- why do Albertans want to ship all the tar sands unprocessed in the next 10 years is my question to my friends out west.
Build refineries, hold the foreign interests accountable to your future- just tell them- if you build it, the processed bitumen will come- in fuels, plastics and a whole host of higher value adding outputs.
It is the west’s future and it would be such a terrible waste to just sell it for trivial amounts to the current highest bidder to decimate your built form.