Is it possible to reduce inflation without crashing economy?

According to the former Bank of Canada governor Stephen Poloz, there is a way to tame sky-rocketing inflation without sending economic growth into a dive. He believes a deft approach is necessary for that.

On Thursday, Poloz said that although there will be certain painful side-effects to the inflation fight, a combination of reasonable policy and taking into consideration the transitory inflationary effects of the war in Ukraine, may lead to a scenario where price pressures keep easing without crashing the domestic economy.

“It would be ridiculous to reduce the inflation to 2% immediately since some of it is going to go away by itself, and of course it would be as ridiculous to just ignore it and wait for something to happen,” – he noted. “So somewhere in the middle of that, we have this method of taking some-of-this and some-of-that, but there’s no painless way to reach the necessary result because of what is happening in Ukraine.”

The annual inflation has slowed down from its June peak of 8.1%, with September showing 6.9% pace – more than three times the BoC’s target level of 2%.

The main reason for that drop were moderating gasoline prices, with the average of the three core measures remaining unchanged at 5.3% last month.

In September, grocery prices were up by 11.4%, marking the largest increase since 1981.

Although Canadians have been changing their spending habits (the latest poll by the central bank shows that more than 80% of Canadians are taking measures to deal with inflation growth), Poloz said there are also other factors affecting businesses’ attempts to fight the inflation.

“There are some mechanisms influencing inflation that people rarely talk about, for instance, how much less disposable income people have these days. According to Walmart, they had a lot less stuff in the basket,” – he said.

“How does Walmart react to that? They’re going to reduce prices: this is a disinflation; it’s not about crushing the economy. So, in my opinion, we have a lot of those preconditions there that are helping.”

The possibility of a larger rate increase has caused forecasts of a recession in Canada next year. Scotiabank expects a technical recession (two quarters of negative economic growth in a row) in 2023 and a rate increase by one more percent by the year’s end.

Although Poloz admits that a recession is the most likely scenario for the domestic economy, he believes the strong labour market should soften the hit and transform such a decline in economic activity into an adjustment to more normalized conditions.