SPECIAL REPORT

INFLATION OR JOBS?

Canadian workers are paying a high cost for price stability

JENNIFER WELLS October 7 1996
SPECIAL REPORT

INFLATION OR JOBS?

Canadian workers are paying a high cost for price stability

JENNIFER WELLS October 7 1996

INFLATION OR JOBS?

SPECIAL REPORT

Canadian workers are paying a high cost for price stability

JENNIFER WELLS

Pierre Fortin presents his slight, soft-spoken, thoughtful self and ever so humbly submits that he is, simply, a “missionary” spreading a simple gospel. Then, he very pleasantly goes on to describe how the Bank of Canada, in his view, has been so wrongheaded in its monetary policy. The country, he says, has been slammed by an unemployment penalty not seen since the Great Depression. The losses are not only irretrievable but still accumulating, and when historians look back on the Canada of the 1990s, they will remember it as the decade of The Great Canadian Slump.

Which is certainly how it feels thus far. As the export end of the economy has charged ahead, the domestic economy remains mired in a gulag of 9.4-per-cent unemployment. Wages have gone nowhere, workers are insecure, and those who have not been downsized fear they may be next. As a result, consumers, already laden with debt, have kept their pocketbooks firmly zipped.

Fortin, a professor of economics at the University of Quebec in Montreal, lays the blame squarely on monetary malpractice— that is, the Bank of Canada and its zero inflation policy. Zero inflation. A neat combination of words that conjures for Canadians the ghostlike spectre of John Crow, the Jacob Marley of economists. It was Crow who, as governor, set the Bank of Canada most firmly on its zero inflation course in 1986. It was Crow who, in the late 1980s, ratcheted interest rates ever higher in order to squelch inflation— remember 19-per-cent mortgages? And it was Crow, twinned with then-finance minister Michael Wilson, who argued that only by attacking both the deficit and inflation would Canada be seen as a credible player on the world stage. In the spring of 1989, the Bank governor addressed the Rotary Club in Kitchener, Ont. “I am well aware that the increases in short-term interest rates and the exchange rate over the past year or so have seized the attention of Canadians,” said a typically aseptic Crow. On a warmer note, he added that “The Bank of Canada gears its actions to the needs and circumstances of the country as a whole.” In February, 1991, he cast his inflation targets three years ahead: for the end of 1995 he targeted inflation at a bracing two per cent. The recession took the country there the same year the target was set.

Crow’s term as governor was not renewed after the Liberals trounced the Tories in 1993. The same Liberals, two years earlier, had rejected the Mulroney government’s proposal to reframe the bank’s mandate as, simply, an inflation fighter for price stability. The bank, said a subcommittee that studied the issue, must preserve its broader mandate, to aim to sustain high levels of economic growth and employment.

The Liberals’ decision to replace Crow with Gordon Thiessen seemed to herald a more moderate inflation view. The new governor announced a so-called band of inflation of one to three per cent, which sounded more palatable than Crow’s expected next target, zero to two per cent. But the new governor was not, in Fortin’s view, a moderate at all. By 1995, inflation was closing in on one per cent.

All of this, argues Fortin, matters mightily. He dismisses other oftcited explanations for the slump at home: globalization, technological change and political uncertainty among them. Instead, he argues, “Pursuing the extreme goal of zero inflation has forced the Bank of Canada to impose permanently higher unemployment through higher interest rates.” Backing Fortin up is a triumvirate of economists at the Brookings Institution in Washington. The three, including senior fellow George Perry and George Akerlof, landed their treatise on the topic just before Fortin did. “The price of operating at zero inflation,” says Perry, “is one to three percentage points of unemployment.” The “transitional effects” of pushing to zero are not transitional at all. “The costs brought on are permanent costs and they don’t go away just because you’ve got there,” he says. Perry, like Fortin, says a “moderate” rate of inflation should be the target, though he does not define moderate. “There is no magic number,” he says. “There isn’t a cliff you fall off,” when inflation

moves to four. But it’s the converse he’s worried about. “The costs rise sharply as you approach zero.”

Aside from such inflation hawks as U.S. Senator Connie Mack, the Americans do not seem fixated on zero inflation as an economic Holy Grail.

The Federal Reserve Board, led by chairman Alan Greenspan, seems comfortable when inflation nudges or even surpasses three per cent.

So what is Perry so worried about? Pierre Fortin smiles. It is no coincidence that this small group of economists can be heard echoing one another’s views. Fortin and Akerlof are both members of the Canadian Institute for Advanced Research. CIAR is footing part of Akerlof’s salary, freeing him up for more economic research. “He felt [the paper] would be a good way to say thanks to Canada,” says Fortin. Akerlof and Perry “see the Canadian experiment as proof,” he says, that the zero inflation argument is misguided. “They don’t want to see the Canadianization of American monetary policy.”

Shortly after the release of the Brookings work, Paul Krugman, a noted American economist, observed that there was “some evidence” that a push to zero inflation “may lead not just to a temporary sacrifice of output but to a permanently higher rate of unemployment.” He cited Fortin, and Akerlof and Perry.

The discourse has sounded like a long overdue entry of the nearleft into policy issues ruled by the right. And that has Bay Street apoplectic. “At the very moment that the payoff is at hand, there are uninformed voices that threaten all the progress that has been made,” says Paul Summerville, chief economist at RBC Dominion Securities in Toronto. Summerville just got back from Europe. “European investors all believe the Canadian story is true,” he says.

“John Crow and the Bank of Canada had to raise interest rates to restore credibility, [to assure investors] that Canada wasn’t going the way of Zambia.”

The payoff, he says, is here.

Short-term interest rates have come way down and now sit well below U.S. rates. Last week, residential mortgage rates, which have been much slower to move, finally fell, with one-year rates dropping under six per cent. A $100,000

‘A miracle has happened. Don’t these people know that?7

mortgage amortized over 25 years now costs $664 a month, versus $1,000 at the peak in 1990. “What better number do you need than that?” Summerville yells, getting very excited. ‘The key to rising productivity, wage gains and job growth is low real interest rates,” he says. “The numbers are telling you that what Crow did was right, and God forbid if he hadn’t done that. A miracle has happened. Don’t these people know that?”

But if Canada is off the “drugs of debt, inflation and currency devaluation,” why does it feel so awful? ‘Withdrawal,” Summerville says. ‘We’re just about to benefit from the 10 years of withdrawal.” Canada, he predicts, will outgrow all other G-7 countries for the next three years. European investors today, he says, are giving the country “a standing ovation.” People like Fortin, he says, should get out more, head to Frankfurt, places like that. Moving the inflation band, allowing for Fortin’s four per cent at the high end, would mean nothing less than “economic ruin.”

But Summerville’s take on the international community only highlights the bitterness still felt at home. For two years now, the Chrétien government has been praying that the domestic economy would find its vital signs. It is waiting still. That is the most powerful reason why Fortin’s views have had such an airing. Certainly inflation targeting will be on the agenda for the annual Bank of Canada conference next spring. Pierre Fortin is a pragmatist. He figures that with economists such as himself calling for inflation slack, the Bank of Canada is less likely to embrace a zero inflation target. In the meantime, Fortin is set to take his argument to a C. D. Howe Institute conference later this month. One of the right-leaning think-tank’s adjunct scholars will be there to voice his views. His name is John Crow. □