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Could we return to 1980s-level inflation in Canada?
High inflation over the past year has led some people to wonder whether we’re in for a repeat of the 1980s, when inflation reached about 12.5% in 1981. That year, the BoC’s benchmark rate inched above 20%, and the prime rate neared 23%. How high were mortgage rates? Above 21% in late 1981. But can we realistically revisit those inflation and interest rate heights?
The inflation of the 1980s was caused by a heady mix of factors: rising oil prices as a result of the energy crises of the 1970s, increased government spending, and relaxed monetary policy in pursuit of full employment through the 1960s and ’70s. The pursuit of economic growth and full employment led to higher wages, which further exacerbated the inflation crisis. Additionally, the Bretton Woods monetary system (instituted by dozens of countries, including Canada, at the end of the Second World War) had collapsed in the early 1970s, leading to the U.S. dollar being unpegged from gold. This led to increased monetary supply—which contributed to rising inflation.
Thankfully, according to some experts, comparisons between the current environment and the 1980s might be overdone, because there are fundamental differences between the two periods. One such key difference is inflation targeting. Unlike in the 1980s, the BoC and other central banks now frame policy with the primary aim of maintaining a target inflation rate rather than promoting full employment, which leads to increased inflation. “We’re not revisiting the 1980s,” Wright says, in no small part because “Inflation targeting has been a great success story around the world. [Over the years] major global economies have moved to targeting.”
Wright notes that a “moderate recession is expected in the second half of [2023],” and while recessions may be painful, “If you look at history, one of the foolproof ways of getting inflation down is having a recession.” This view is echoed by Grantham. “There are a number of differences between the current economic situation and that of the 1980s,” he says, “but an important one is that businesses and households still on average believe that inflation will return to 2% over time.”
Both Wright and Grantham stress that the high inflation of the 1980s was—at least partially—a result of heightened inflation expectations. If inflation is expected to be high, then businesses and households behave in a way that fulfills this prophecy. Inflation targeting, which the BoC first implemented in 1991, mitigates this risk, because economic actors believe rates will continue to rise until the target of 2% inflation is met.
Global headwinds that could make inflation worse in Canada
The war in Ukraine, extreme weather events and a resurgent Chinese economy are global events and trends that could lead to stickier inflation in Canada. Wright believes that some future inflationary pressure could come from de-globalization, challenging demographic trends, and potential regulatory or tax changes that support a global move to net-zero emissions.
Another factor that could contribute to high inflation is the rising price of food and other goods, which could result from “supply chain disruptions emanating from the Russia/Ukraine war” and “extreme weather events [which] appear to be becoming more common,” notes Grantham. Finally, a “re-acceleration in Chinese economic growth, which has disappointed recently, could also result in higher inflation particularly through metals and energy prices.”
Is the BoC’s target inflation rate of 2% still achievable—or even desirable?
In June 2022—when inflation peaked at 8.1% in Canada—there was some debate on whether the BoC should increase its inflation target. However, the issue feels less relevant now, with the Consumer Price Index (CPI) already down to 2.8%. Wright believes that the 1% to 3% target band need not be altered, even though achieving it won’t be as easy as in the previous decade. He also points out that the inflation target is set for five-year periods—the current target being for 2022 to 2026—allowing for future changes based on economic conditions.
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