Economist Benjamin Tal began his Vancouver Real Estate Forum presentation by stating the Cold War is back, the world’s battle with COVID continues, inflation is at a 40-year high and rising, interest rates are projected to rise at a rate not seen since 1994 – and policymakers are impotent in their ability to deal with the situation.
Then, to much laughter, he said, “Good morning, everybody.”
However, Tal offered some cautious optimism during his April 12 address, too, depending on how one views the pandemic.
He said we are quite possibly in a year transitioning from pandemic to endemic, and because around 60 to 65 per cent of inflation is COVID supply chain-related, that pressure from COVID could ease off within the next year.
“. . . If you agree with that assumption that this is a transition year, that (COVID-related inflation) should disappear over the next year,” said the deputy chief economist at CIBC World Markets, who opened the annual conference.
Pandemic fuelled goods consumption
In the pandemic year 2021, goods consumption skyrocketed, which severely burdened the supply chain. For that reason, inflation is not due to the supply chain itself so much as demand shock, Tal said.
“In 2021, we are talking about a situation in which four years of consumption was squeezed into one year in terms of growth. That’s crazy. Why is that? That’s because you press a button and you get an exercise bike (delivered to your home). It’s easy . . .
“How much stuff do you need? We have been consuming for two years now.
“Even a normally functioning supply system will have difficulties dealing with this mother of all demand shocks. . . . A sick supply system trying to deal with a huge demand shock; of course you will have prices rising.”
But, he asked that we remove COVID from the equation, or at least assume 2022 is a transition year from pandemic to endemic.
“You will start to see things improve,” he said. “The point I am making here is that this story, 60 to 65 per cent of the inflation we are seeing now – not all of it, but a big part of it – is COVID-related. If you all agree with that assumption that this is a transition year, that should disappear over the next year.”
The services sector, energy and inflation
He predicted the demand will likely move away from goods and into services, which is far more elastic and less inflationary. For example, if a restaurant overcharges, then another cheaper restaurant opens up nearby.
Another key factor is energy inflation and we’ve become more efficient over the past decade in our use of energy with new furnaces and other energy-saving measures. That means the economy is less sensitive to gasoline and energy shortages and high prices.
“So that’s more or less where we are. Sixty per cent of inflation is COVID-related supply chain that over the next year should disappear, or at the minimum, will not be dominating the agenda the way it is now.”
The labour market is another factor, particularly the shortage of construction workers and high wages.
There was also the arrival of 405,000 new immigrants in 2021 — an increase not achieved since 1913. Seventy per cent of them were here already because they were students and other temporary residents, said Tal. Instead of leaving after their visa expired, they were invited to stay.
The advantage of this source of new immigration, he said, is that they are already here, they speak the language, are employable and can participate in the housing market.
“Economically speaking, it will be a zig zag, up, down, up, down, dancing to the tune of the virus. We are getting three to four per cent GDP growth in 2022, but it will be a zig zag.
“The first quarter was better than expected, this quarter is excellent, this summer I think will be on fire, and then fourth quarter, we’ll see. It depends on the variant.”
Rising interest rates
Tal also said interest rates need to rise, but in small increments to avoid triggering a recession.
The day after Tal’s Vancouver talk. the Bank of Canada raised interest rates by 50 basis points, the biggest hike in two decades. He saw that coming.
“Your enemy is not higher interest rates. We need higher interest rates. Your enemy is rapidly rising interest rates,” he said. “Every economic recession over the past 40, 50 years was helped, if not caused, by monetary policy error in which central bankers raised interest rates way too quickly.
“I must admit that now we are facing that risk, because central bankers are also human and monetary policy works with the line, ‘You raise interest rates nothing happens, what do you do? You raise again, and you raise again.’ The next move will be 50 basis points. We know that.”
As for the Bank of Canada, Tal said, “They get it.”
They know that monetary policy error has caused previous recessions, he said.
“So the hope and the prayer is at first they will go fast . . . but maybe they will stop at 2.25, which is the neutral rate of interest, and then rest and see what happens.
“Especially in Canada, with the increased sensitivity to higher interest rates, that might be enough. You go beyond that and you risk a recession in 2023,” he explained. “Let’s avoid that. My communication with the Bank of Canada is, start fast but then go baby steps.
“Don’t go over 2.25 because there is no need to. The economy will adjust.”