Which should we fear more, inflation or recession?

Ashleay: Welcome to the “In Your Interest!” podcast from iA Financial Group, where we discuss your need-to-know economic news and how it affects your finances. All this in under 10 minutes. Our question today: Should we fear inflation more or recession? My name is Ashleay. I'm here with my colleague Sébastien Mc Mahon, our Chief Strategist and Senior Economist here at iA Financial Group. Hi, Sébastien.

Sébastien: Hello, Ashleay.

Ashleay: So, it's been talked about a lot in this podcast. Recession risks are high for 2023, and inflation remains a problem. The Bank of Canada is working hard to solve the inflation problem, but probably by pushing the economy into a recession. So, a question for you. Why is it doing this?

Sébastien: Well, it's a very interesting question. They're not Bond movie villains that are just trying to push the economy off a cliff. All right. So, what they're trying to do is they're really trying to solve the inflation problem. And the reason is that inflation has been one of the main economic enemies, I would say, of the 1970s, 1980s. It was creating lots of pressure for multiple households, lots of uncertainty for businesses. Inflation has been termed as one of the public enemy number one for the U.S. economy by a former president. So, inflation, a lot of work has been done by central banks. They know that they need to keep it low. How low? They settle in about 2%. They need to keep it pretty stable so that you can forecast into the near future if you want to make business decisions. And we just task the central banks to keep it like that. So, this is their mandate. This is why they're doing this. But you're right. In doing this, recession might be inevitable.

Ashleay: And why is it less serious to have a recession and more acceptable than having inflation?

Sébastien: Right. So, it's less serious. I think there would be an economic consensus around that. It's not that recessions are, you know, something that you want to see. I mean, when you have a recession, typically you have the unemployment rate tick up by about 2% to 5%. So, this means people are losing their jobs. And it's never a good thing when you know someone, like a family member or a friend or yourself, that is losing your job. But when there's a recession and people lose their job, then you have unemployment insurance that's there to support you. And recessions are just the natural end of a business cycle. After that, you have a new cycle that starts, and new opportunities can arise. And you know, it's just a temporary phenomenon. You can use the time that you're on unemployment insurance to, you know, maybe study something else, to go into another domain. So, you know, it's not something that you would wish, but, you know, there might be some opportunities in there. Inflation, on the other hand, it just bites everyone. I mean, if prices are going up by 6%, 7% a year, like we're seeing right now, and then they come down, the price level won't be coming down after that. So, your purchasing power is likely gone for a good while until your wage increases just make up for lost time. But there are some people that are less fortunate than others that have jobs that they won't be getting promotions anytime soon, or that the rate of increase of their wage won't be enough to make up for the loss in purchasing power that inflation brought. So, it brings you know, economic misery to the population when inflation is high and when it's volatile.

Ashleay: I see. And so, a recession is normal or, you know, an inevitable phenomenon. But inflation is not.

Sébastien: Yeah, exactly. A recession is just the end of a business cycle. I mean, we've had an experiment in the early 2000s, you know, when the economic cycle, when it was slowing down, we had central banks just keep rates low. That led to a long and prolonged economic cycle that led all the way to 2007, 2008. And we all remember how it ended. If you try to delay the inevitable end of the business cycle, thus the recession, usually what you see is you see bubbles starting to inflate left and right. This time it was in housing in 2008 and even just recently, when you have too much support for the economic cycle and too strong an economic cycle because of liquidity, then you see speculation starting to appear with like cryptos and with NFTs. So, it's normal at some point to have an end to a business cycle just to have, you know, a resetting of things, a start of a new business cycle. So, it's completely normal and it's inevitable and it's predictable. Inflation, on the other hand, we've learned from history that central banks can be good enough to at least keep it on average around target, making things predictable for everyone. And that really helps with the prospects for growth and for the well-being of the population.

Ashleay: I see. And we hear all kinds of numbers about inflation, right? Annual, monthly, core. As an economist, what are you looking at specifically right now?

Sébastien: Right now, myself and other economists, we're looking at the monthly figure. So, the inflation right now, month to month, because what happened last year, of course, it was pandemic then post pandemic. So, it doesn't really tell us any new information. But the pace of inflation right now, or even if you look at the last three months and you projected, you just annualize that, you project that 12 months forward, you start to see that inflation is slowing down. So, it's a good thing. Core inflation, as you said, when you exclude food and energy, the behaviour of that is the more sticky parts of inflation. This is what we're looking at. We're starting to see inflation coming down. That's good news. But the issue is that it's coming down in some specific sectors, like energy prices, used cars, new cars. Inflation in the price of food is still accelerating. Inflation at the pump is still very high. Inflation in shelter is still accelerating. So, we're far from the end of this fight by central banks against inflation.

Ashleay: I see. And maybe that can kind of explain that saying that some of our grandparents used to say where inflation is the mother of all evils. Maybe you could explain a bit more about that.

Sébastien: Yeah, exactly. It was the mother of all evils because it was hard to forecast ahead because when inflation tends to settle, it tends to settle in a volatile way. So again, businesses, if they look forward, they say, right, what will inflation be over the next few years? Then if inflation is expected to be high and volatile, it's hard to plan for, well, how much should I invest or should I go forward with my investments? How many people should I hire and should I move forward with that? If you're a household, you say, right, I want to buy a house. Well, with inflation being high and volatile, can I make sure that I will be able to afford this house for a long time? What will my purchasing power be in the next few years? So, that brought so much, so many issues, I would say, to the population, to households, to businesses that it's been named the mother of all evils.

Ashleay: I see. And so, I'm convinced inflation is something to be avoided when we can. But isn't recession also kind of the mother of all evils in a way?

Sébastien: Yeah. Recessions are not fun, especially if, as I mentioned earlier, if you or you know someone that, you know, lost their jobs. But recession is just a normal part of the process of the business cycle. When we have a recession, you have central banks cutting interest rates to make sure that, you know, the cycle can start again. The government can help with the fiscal measures. So, you know, it's just a necessary evil, I would say, that we can get back up from. But I would say the mother of all evils title, I will give it to inflation.

Ashleay: Great. And so, do you think this will end well?

Sébastien: Well, the current situation, I think we're actually not in too bad shape. And I hope that this will be aging well—this is a podcast that we're recording now—because when you look at the labour market, it is pretty tight. It's hard to get people. If you want to hire people, it's very hard. So, we can have kind of an atypical recession where we don't see the unemployment rate jump by quite a lot. And a question I like to ask to audiences when I do face-to-face presentations is I ask everyone, “Do you remember the recession of 2015?”. There was a recession in Canada in 2015, and not many people raise their hands, even financial specialists, economists, because in most of Canada we didn't really feel it. In Alberta, I know that there are a lot of hands that get raised because it was the price of gasoline, of oil that fell. We had lots of jobs that were lost over there, you know. And multiple people in the room, they knew someone who lost their jobs. They've experienced that firsthand. And, you know, if we have a job for recession, maybe it’s something that will not go down in history as a terrible period for the Canadian economy.

Ashleay: Very interesting as always, Sébastien. Thank you so much for sharing all this with us. And to everyone listening to us, don't hesitate to leave a review, talk about the podcast to your friends and sign up for our next podcast. Love this podcast? Want to know more about economic news? Follow our “In Your Interest!” podcast available on all platforms, visit the economic news page on ia.ca, or follow us on social media.