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Recession in Canada – Both inflation and jobless rate will increase

Recession in Canada – Both inflation and jobless rate will increase

Royal Bank of Canada has predicted that there will be a modest recession in Canada 2023. Their newest prediction is that this decline will start in the first quarter of next year. Increased costs and interest rates will reduce the average household’s purchasing power by $3,000, which will have an impact on what they can buy. Canadian households and businesses won’t feel the effects of the next recession equally. Manufacturing will probably be one of the first industries to start contracting, although other high-contact service industries, including tourism and hospitality, may do better than in a ‘typical’ historical recession.

As an exporter of commodities and a nation that performed pretty well through the pandemic, Canada has been affected by the war in Ukraine less severely than many other nations. Despite this, the pandemic continues to pose a risk, inflation is much above goal, and residential affordability is a key worry following a protracted boom that may have reached its peak. Staff anticipates continued significant economic cooling, with downside risks to growth and the possibility of a mild recession in the event of shocks.

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Inflation has become Canada’s main macroeconomic challenge

According to the IMF, inflation has become Canada’s main macroeconomic challenge. The problem has been exacerbated by rising commodity prices, particularly following the Russian invasion of Ukraine, and supply-chain disruptions, but excess demand in the economy and the concomitant tight labor market—which has also been fueled by a decrease in immigration since the pandemic—have assumed increasing significance and have contributed to inflation reaching its highest levels in a generation.

The pressure of the economy is already being felt by households. Inflation, borrowing, and debt payment costs are predicted to increase, reducing the average consumer’s purchasing power by roughly $3,000 by 2023. Additionally, despite the fact that earnings have increased due to the tight employment markets, these gains have not been sufficient to make up for these losses. The majority of the burden will fall on Canadians who are less wealthy, especially those whose disposable money has declined along with support for the pandemic.

The unemployment rate to rise to about 7% by the end of 2023

The labor market is currently at its tightest point in decades. In the very near future, a significant increase in unemployment will be prevented by a surplus of job openings and a shortage of employees. The unemployment rate will continue to climb, but we anticipate longer job search periods for the unemployed and initially reduced hours for the employed.

There will be more outright layoffs to come, and we anticipate that the economy’s deterioration will cause the unemployment rate to rise to about 7% by the end of 2023, up nearly 2 percentage points from its recent low of 4.9% in June and July. This is still low compared to prior downturns while being slightly higher than our previous forecast.

Financial stability is threatened

Risks to financial stability are increasing, but the system should be able to withstand the cycle of tightening. The majority of the banks’ principal borrowers are anticipated to remain sound because households should generally be able to continue paying their mortgages and listed nonfinancial corporates are in better shape than in the past. Banks are typically well capitalized and liquid, their net interest margins are increasing as rates rise, and they are seeing their net interest margins.

Nonbanks appear to be financially sound as well, including Canada’s sizable insurers and pension funds, though complete data are not readily accessible. They are now holding a bigger portion of riskier and less liquid assets as a result of their yield-seeking over the previous ten years, while also relying on repo financing and derivative hedging. However, it appears that they generally functioned well during the “dash for cash” episode in March 2020, and they should be in a good position to avoid liquidity squeezes going forward.

Fiscal and monetary policy to reduce recession in Canada

Fiscal and monetary policy to reduce recession in Canada

Fiscal policy

The implementation of rules-based automatic stimulus could further improve fiscal policy (expansionary fiscal policy). According to a predetermined macroeconomic trigger, such as an increase in unemployment above a predetermined level, such a mechanism would require temporary spending increases (for example, on household transfers). Households and businesses would be less unsure and more likely to spend money if the government sent a clear signal that it was supporting them. This would hasten the recovery of the economy. Rules-based stimulus could be a beneficial addition to the policy toolkit for managing future downturns by combining the rapid implementation of monetary policy with the rapid effectiveness of fiscal policy.

Monetary policy

Sound monetary policy is more effective when there is better communication. It’s a good thing that the Bank of Canada recently decided to start providing summaries of Governing Council discussions because it aligns it with international best practice. Additionally, the inclusion of scenario analysis in the July Monetary Policy Report should aid markets in understanding the main risks. Other improvements could be taken into consideration to further the markets’ understanding of the Bank of Canada’s decisions. For example, the Bank could publish the rate path that underpins the quarterly economic forecast in addition to adding more quantitative discussion of changes in the policy stance associated with alternative scenarios to complement its qualitative guidance on the policy rate. 

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