Soft landing scenario to lighten mood at Liberal cabinet retreat, though caution remains in order
Prime Minister Justin Trudeau and Finance Minister Chrystia Freeland head into a cabinet retreat next week with plenty of wind in their economic sails. While Canada’s economy is poised to gear down in the first half of this year, and may even enter a mild recession, recent job and inflation data suggest the coveted soft landing remains in reach.
Weakening commodity prices, repaired global supply chains and higher interest rates are acting to slow economic activity and ease global inflationary pressures. By the time parliament breaks for summer in June, economists expect Canadian inflation will have fallen to below four per cent, from 6.3 per cent in December.
To be sure, the unemployment rate will also probably be higher, but it will be rising from historically low levels.
Economists see the jobless rate up to between six per cent and 6.5 per cent this year, from about five per cent now. That will still leave it below average for the decade preceding the pandemic. The best case scenario is that we’ll see an inflation-killing recession without any major loss of employment – a very sweet outcome.
On the fiscal side, a soft landing means the revenue track projected by Freeland in her November budget update remains largely intact, with the deficit settling in at about one per cent of GDP over the next couple of years – a respectable fiscal position.
Keeping expectations low
Overall, it’s a relatively friendly macro environment that will lighten the mood at the cabinet meeting in Hamilton. Trudeau and Freeland, however, would be wise to keep their colleagues’ expectations low.
First, economists are often wrong, particularly when it comes to big shifts in economic conditions.
Few predicted last year’s bout of inflation and history shows soft landings almost never happen, and a deeper recession shouldn’t catch anyone by surprise.
Second, the government is extremely overextended on the fiscal side. Basing budget forecasts on a benign economic environment would be a risky strategy.
There are political pressures to raise health transfers, boost spending on defense, help finance the climate transition, respond to Joe Biden’s industrial subsidies, pay for new social initiatives under the Liberal-NDP agreement and eventually to put something expensive in the shop window for the next federal election. While few politicians are talking about it, there’s also a good case to be made for repairing some of the fiscal damage from all the pandemic spending.
Looking long term
Yes, the fiscal trajectory is on track for a balanced budget within five years, but many of these pressures aren’t baked into the numbers yet.
Raising taxes could be a solution, though it’s probably a political non-starter at a time when the federal government’s weight in the economy has already grown substantially.
Based on the November projections, the federal government expects its revenue as a share of GDP to settle at just over 16 per cent – which is where it was in the early 2000s. It’s not difficult to imagine an even bigger take would start to crowd out the private sector in a big way.
A third consideration for the Liberals: the tough inflation fight still lies ahead for the government.
Inflationary momentum
Getting inflation down to four per cent may prove to be a lot easier than bringing it back to the central bank’s two per cent target. While energy prices have eased and kinks have been removed from global production chains, the supply shock has infused Canada’s economy with a certain amount of domestic inflationary momentum that will be difficult to pluck.
Statistics Canada data released on Tuesday showed inflation for services was at 5.6 per cent in December. That’s up from 5.2 per cent in June, even as headline inflation has tumbled on the back of falling energy prices. The government can no longer argue that inflation is being driven by globally-traded goods.
Squashing that momentum may turn out to be a lot trickier than expected and ultimately require a much deeper downturn to engineer. The governing Liberals may want to wait before getting their hopes up too high next week.
Recent dispatches
Budget prep begins amid January slumber