Weakness in economy is structural, not cyclical: Macklem

Key Concepts

• Structural Adjustment: The process of an economy adapting to significant changes in its underlying conditions, such as shifts in trade, technology, or global economic forces.
• Tariff Shock: The economic disruption caused by the imposition or alteration of tariffs (taxes on imported goods).
• Monetary Policy: Actions undertaken by a central bank to manipulate the money supply and credit conditions to stimulate or restrain economic activity (e.g., adjusting interest rates).
• Fiscal Policy: Government actions related to spending and taxation to influence the economy.
• Inflation: A general increase in prices and fall in the purchasing value of money.
• Core Inflation: A measure of inflation that excludes volatile components like food and energy prices.
• Headline Inflation: The overall inflation rate, including all components of the consumer price index.
• Inflation Expectations: The beliefs that individuals and businesses hold about future inflation rates.
• Credibility of Central Bank: The degree to which the public trusts a central bank to achieve its stated policy objectives, particularly inflation targets.
• Labor Market Stability: A state where the number of jobs created is sufficient to offset job losses, maintaining a consistent unemployment rate.
• Population Growth: The increase in the number of people in a country or region.
• Per Capita Measures: Economic indicators calculated on a per-person basis (e.g., GDP per capita).
• Affordability Shock: A significant and rapid increase in the cost of living that outpaces income growth.

Economic Outlook and Structural Adjustment in Canada

The Bank of Canada's current lending rate of 2.25% is considered by Governor Tiff Mlham to be at an appropriate level to maintain inflation near the 2% target. However, Francis Donald, Chief Economist at RBC, highlights that the Canadian economy is undergoing a significant "structural adjustment," a "new reality" that businesses and households are actively navigating. This adjustment is characterized by ongoing adaptation to "tariff shock," with the future of tariffs remaining uncertain due to reviews like the KUSMA review.

Donald argues that while the Bank of Canada's monetary policy can offer some relief on interest rate burdens for struggling Canadians, it is not the primary tool for facilitating this structural adjustment. Monetary policy cannot directly assist in reskilling or retooling the economy, nor can it help diversify trade. Furthermore, it is not effective in addressing economic shocks that cause extreme pain in specific regions, such as southwestern Ontario, while leaving other areas relatively unaffected.

The key message for Canadians, according to Donald, is to shift focus away from the Bank of Canada as the sole solver of economic woes. Instead, greater attention should be paid to the upcoming budget on November 4th, which is deemed better suited to target specific economic pain points and support Canada through its "massive structural adjustment."

Trade Deals and Immediate Relief

Regarding the potential for a trade deal with the US to provide quick relief, Donald clarifies that a trade agreement already exists. However, specific sectors like steel and aluminum, and regions like southwestern Ontario, require immediate relief from current tariff impacts. While the government is best positioned to provide this support, Donald emphasizes that a singular "trade deal" is unlikely to be a panacea.

Instead, ongoing discussions will focus on issues like Section 232 tariffs and export diversification. The process is not binary; it will involve detailed negotiations and incremental progress. This complexity contributes to high uncertainty in Canada, leading to low business confidence and making it difficult for households to make significant decisions, especially those potentially impacted by trade deal specifics. Donald stresses that "clarity" on these trade matters, rather than an aggregate "trade deal or no trade deal" outcome, will be the most impactful going forward.

Economic Recovery and Refocusing

The question of recovering what has been "lost" depends on the definition. Donald suggests that a return to the prior state of the automotive sector is unlikely. However, he believes that an economy capable of acceleration and improved productivity is possible through substantial investment in the right areas and trade diversification. The focus should not be on returning to the economic conditions of a year ago, as using policies designed for the "old economy" may not be effective in the "new economy."

The structural adjustment means that segments of the economy will not resemble their past configurations. This necessitates a "regionalization and sector by sector focus." The situation is not simply about moving backward or forward; some areas are heading in entirely new directions that were not even conceivable six months prior.

Inflationary Pressures and Expectations

While Governor Mlham notes that core inflation has been "sticky" but inflationary pressures are easing, Donald acknowledges the complexity. Headline inflation is indeed decreasing in Canada. However, many Canadians perceive their cost of living as still being "very high relative to where it was 5 years ago." This indicates an ongoing "confidence shock" around inflation, with concerns about future price increases.

Central banks in Canada and the US (which also saw a rate cut) are likely to be cautious in maintaining inflation expectations around the 2% target. Mlham's emphasis on the "credibility of the central bank" around the inflation target, particularly in Canada with its single mandate, is crucial. Canadians are highly sensitive to inflation due to experiencing "one of the greatest affordability shocks of their entire lives."

Immigration and the Canadian Labor Market

The upcoming budget is expected to address immigration, which Donald anticipates will impact the Canadian labor market. A notable point from the Bank of Canada is that only 5,000 jobs per year are needed to maintain labor market stability. However, with many individuals on the sidelines seeking employment, more than 5,000 jobs are likely required to achieve a more reasonable unemployment rate.

The reduced need for job creation compared to previous years is attributed to population growth slowing towards 0%. This demographic shift will influence various economic indicators. It may lead to an appearance of lower consumption growth, simply because there are fewer people. Per capita measures, which previously showed the economy growing but individual slices shrinking, might see a reversal. This is largely a statistical effect of the "denominator" (population size) rather than a fundamental shift in economic output per person.

Donald cautions against misinterpreting these aggregate numbers, emphasizing that the impact on everyday Canadians' daily lives will be more significantly influenced by general inflation and job growth than by population-driven statistical changes.