Prominent Bay Street economist disputes Bank of Canada's assertion that wages are stoking inflation


Frances Donald says structural changes such as trade barriers and climate change have fundamentally altered price dynamics

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One of Bay Street’s most prominent economists questioned the Bank of Canada‘s emphasis on wage growth as a driver of inflation, arguing that structural changes such as a proliferation of trade barriers and climate change have fundamentally altered price dynamics.

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“We need to move away from the standard ways we talk about inflation,” Frances Donald, chief economist at Manulife Investment Management, told the Financial Post’s Larysa Harapyn. “The new inflation, and in my view, the inflation that is going to permeate the system in Canada and abroad for the next several years, and probably the next few decades, is a different type of inflation that’s going to be increasingly driven by global factors, supply-side factors, climate change, all of these issues are going to push inflation higher.”

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Donald, the youngest chief economist at a major Canadian financial institution, added: “Focusing on these old arguments that there is wage growth, frankly wage growth is good for Canadians. Central bankers have been looking for wage growth for over a decade. That’s not where the focus needs to be. The focus needs to be on, what are the future drivers of inflation and why do we need to think about prices differently than we have over the past several decades.”

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Average hourly wages have been growing at an annual rate of around four per cent to five per cent for the better part of a year. The Bank of Canada says that’s contributing to “excess demand,” because it’s calculations suggest wage growth of more than about three per cent encourages households to spend at a pace greater than the economy’s capacity to keep up with orders.

That mismatch between demand and supply inevitably puts upward pressure on prices.

Frankly wage growth is good for Canadians

Frances Donald, chief economist, Manulife

“There’s so much more at play,” said Donald.

The Bank of Canada initially blamed the inflation surge on factors that were largely out of its control, such as supply disruptions caused by the pandemic and Russia’s war in Ukraine. But as price pressures grew more intense, policymakers determined that homegrown factors such as labour shortages, low unemployment and government spending also were important factors. And more recently, as supply constraints have eased and energy prices have dropped, the central bank has highlighted wages and the “pricing behaviour” of corporations as indicators that will determine whether it resumes raising interest rates.

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Donald questioned the premise for higher interest rates, noting much has changed since “our economics textbooks told us that if we trade openly with our trading partners, prices come down and that’s good for everyone.”

To be sure, since the 1930s, as globalization took root, open markets led to “a lot of great outcomes,” she said. However, “now, the big question is, are we actually going to see this paradigm shift where, the nature of globalization changes, we begin to see de-globalization types of tendencies?”

A CN Rail train is loaded at the Port of Vancouver in 2022.
A CN Rail train is loaded at the Port of Vancouver in 2022. Photo by Jason Payne/PNG

Donald said if that happens, it would be a “massive disruption” to how economies function, trade flows and goods and services prices are set. In that context, merely looking at demand and supply equations to determine interest rates is a dated exercise, she added.

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The Bank of Canada’s interest rate hikes have so far been effective at bringing inflation down from 40-year highs. The consumer price index, which measures inflation, peaked at 8.1 per cent in June and the latest data showed growth slowed to 4.3 per cent year over year in March.

At 4.5 per cent, the central bank has taken a pause on hiking rates to monitor signs of economic cooling, but it raised rates at the fastest clip on record to tame inflation that was pushing above five per cent starting last year.

External factors, such as energy and food prices, have been major inflation drivers since 2021. As such, “a different type of inflation” will “permeate the system” in Canada and abroad over the next several years or decade, Donald said.

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“We shouldn’t discount that a lot of food price inflation we’ve seen have come from a conflict in Eastern Europe, weather patterns that have led to substantial droughts, even things like avian flu — these are not interest-rate sensitive factors,” she said.

“We can hike interest rates all we want but it’s not going to make it rain in Brazil.”

Of course, the traditional drivers are still important and economists need to take those into consideration, she said.

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“It’s time to widen our horizons,” Donald said.

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