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Interest rate hikes can't be only way to tame inflation, says Canadian economist

Government should target corporate profits, says economist David MacDonald.
david macdonald
Canadian Centre for Policy Alternatives, senior economist David MacDonald.

The Bank of Canada’s history of shows it never results in a so-called “soft landing” to avoid a recession, says senior economist David MacDonald.

In a July 5 report for the Canadian Centre for Policy Alternatives, MacDonald suggests government regulations and fiscal policies can assist in taming inflation, as opposed to the “blunt” force of interest rates, which are widely expected to rise 0.75% this month and at least another 0.75% by the end of the year.

This will bring the key interest rate at or above 3%, a far ways from the 0.25% experienced in 2020 and 2021.

“I certainly think the government should be acting much more quickly to do what they can and not just abdicate responsibility to the Bank of Canada, because they'll keep increasing interest rates until they get inflation under control,” MacDonald told Glacier Media in an interview.

The latest annual inflation rate is 7.7% and the Bank of Canada wants it back to 2%. Rate hikes will put greater burden on debt, including mortgage payments, and suppress demand for goods, in theory.

“It’s worth asking, have we actually ever seen a 5.7% point drop in CPI (Consumer Price Index) without experiencing a recession?” asks MacDonald, to which he replies: “In every single instance of CPI reductions of this magnitude in the past 60 years, it was always accompanied by a recession. If modern Canadian history is an indicator, there is a 0% success rate of reducing inflation by 5.7 percentage points and avoiding a recession.

“There is simply no historical precedent for the Bank of Canada engineering a ‘soft landing.’ Each time the Bank of Canada has attempted such engineering through rapid interest rate hikes — which it appears to be set on doing now — it resulted in a crash landing, i.e., recession.”

He points to recessions in 1974, 1981 and 1990 that followed big rate hikes.

A recession today could lead to 850,000 job losses, said MacDonald.

What are the government-led alternatives?

MacDonald says, “It’s worth remembering that inflation is primarily being driven by the unjust war by Russia on Ukraine, driving up gas prices, and supply chain issues in China.”

Higher rates in Canada will not tame the low global oil supply nor will they fix China’s supply chain, he added.  

MacDonald told Glacier Media the government has tools to tame inflation that rate hikes cannot without more serious consequences to the economy.

Government should target corporate profits, which he notes are at record highs as a percentage of the economy, largely stemming from oil and gas companies.

While truckers have asked for gas tax relief across Canada, MacDonald asks, “why should government pay for it?” and suggests profit caps for oil and gas companies could be explored.

“Do you start to shut down the borders and set the price of gasoline and say to very profitable energy companies, ‘You're still going to make a lot of money but you're going to make a little less money’?”

“It's an interesting question as to whether we should start controlling the price of key inputs. You can certainly think of oil; you can think of gasoline. I mean, some other inputs on the food side are probably things like key fertilizers, and the price of diesel,” said McDonald.

Overall, a better competition regime to regulate price gouging by corporations is also needed, he said.

“We've seen quite a historic rebound of corporate profits as a percentage of GDP out at the last recession recovery (the outset of the pandemic), which suggests some pricing power on the part of some companies,” said MacDonald.

He also says suppressing demand in housing by tightening lending through stricter mortgage underwriting policies can help on the housing front.

Other ideas include provincial rent controls and further subsidized child care, which will lower costs included with the Consumer Price Index, albeit for an admittedly minor portion of the population.

Asked about the impact of rent controls on new market rental housing developments and basic upkeep by landlords, MacDonald acknowledges, “there isn't a cost-free way to do this, right?

“I mean, this is worth pointing out, like increasing interest rate is no more cost free than any other way. And so, we need to understand what the costs are in just allowing the Bank of Canada to do its thing, increase interest rates, so it causes a recession” and thus extreme job losses.

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