A lot must go right to achieve soft economic landing, David Dodge says

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From the Russian invasion of Ukraine, to supply chain breakdowns and rampant inflation, policymakers are staring down an unprecedented mix of economic challenges — and they’re going to need a few things to break their way in order manage through it with as little pain as possible.

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That’s one of the takeaways from the Spring 2022 Economic Outlook produced by Canadian law firm Bennett Jones, which examined several potential scenarios and the conditions it would take for each to play out.

In the firm’s optimistic scenario, both Canada and the United States would be able to guide their economies to soft landings as global supply chain problems are gradually resolved and early monetary tightening brings inflation pressures under control.

David Dodge, the former Bank of Canada governor who now serves as a senior advisor at Bennett Jones and was lead author of the report, pointed to inflated global commodities prices in particular as a key obstacle to overcome.

“If we get oil prices down (and) we get that sort of a break, then I think it’s quite possible (to achieve a soft landing),” Dodge said in an interview with the Financial Post. “If we don’t get a break on that front, it’s going to be very difficult.”

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If we get oil prices down (and) we get that sort of a break, then I think it’s quite possible (to achieve a soft landing)

David Dodge

Analysts at Bennett Jones expect energy and commodity prices to peak this year before declining in 2023 and 2024, though they would remain elevated from pre-pandemic levels.

The optimistic scenario would also depend on fading COVID-19 restrictions, especially in China, which is still pursuing a zero-COVID policy, and fewer supply chain bottlenecks. A resolution to Russia’s invasion of Ukraine that would allow for some sanctions to be relaxed would also be necessary to reduce supply constraints and alleviate some of the inflationary pressures they are causing. On top of that, demand growth would need to be brought to heel through large increases in retail prices, tighter monetary policy and reduced fiscal support.

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Under this scenario, the Bank of Canada would bring its policy rate up to 2.75 per cent — within the upper bound of the neutral rate that would neither help nor hinder economic growth that central bank executives have been referencing over the past few months. This would come through a series of three half-point hikes and two quarter-point increases.

All of these factors considered, the report found in the optimistic case that real Canadian gross domestic product would reach 3.1 per cent this year before slowing to 2.4 per cent in 2023 and to 1.7 per cent the year after from declining exports. Analysts added core inflation could hit its peak in the third quarter this year before ebbing off to two per cent by mid-2024.

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However, other threats beyond geopolitical tensions and global supply chain snarls could lead to high inflation persisting into next year, forcing  the Bank of Canada to pull rates considerably above the neutral rate to 3.5 per cent by March 2023. The report added this pessimistic scenario would see inflation, excluding food and energy, peaking at 5.2 per cent annually at the third quarter of this year with a starker drop-off in economic growth to 2.7 per cent in 2022 and 1.1 per cent in 2023. Economic growth would then reverse course and rebound to two per cent the following year.

Prospects of an economic slowdown while inflation remains quite high has stoked concerns surrounding stagflation.

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Dodge said that in order to avoid a stagflation environment, policymakers will have to work quickly from both a monetary and fiscal policy standpoint to bring prices under control.

“We have to move really quickly to (bring inflation down), and … for central banks, that means getting interest rates up to a level where they actually are restrictive rather than just being accommodative for growth,” Dodge said. “And at the same time, we have to allow the rise in prices to do their job, which will be to cut demand where people don’t have enough income — that reduces demand and perhaps some prices. That’s not very nice, but that’s the way the market system works.”

“That is the short-run: the outlook is not very cheery,” Dodge continued, “It’s kind of dealing with the side effects of a superbly successful intervention, which we (and) the rest of the world made in the economy in 2020.”

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Dodge noted that the economy can expect a slowdown for a few quarters as policymakers pull back the stimulus pumped into the market to combat the COVID-19 recession (which the report acknowledged likely exceeded the needs of the economy). However, Dodge said it is an important trade-off compared to the human cost that could have been realized during the pandemic.

“It’s quite possible we’re going to have three or four quarters with almost no growth … as we work our way through this,” Dodge said. “That would not necessarily be a bad outcome given what we were able to save ourselves from in 2020.”

• Email: shughes@postmedia.com | Twitter: StephHughes95