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Spring 2022 Economic Outlook: Planning In An Uncertain, Supply-Constrained World – Fiscal & Monetary Policy

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We present this Bennett Jones Spring 2022 Economic Outlook in a
period of great uncertainty. A war in Europe and the ongoing
COVID-19 pandemic, in addition to exerting a devastating human
toll, have reverberated through the global and Canadian economies.
How these and other external forces will evolve, and how policy
authorities worldwide will respond, are unknowns that make the
development of economic projections and business plans unusually

What we do know, after a strong recovery of activity and
employment from the period of COVID lockdowns, is that the world
today is very different than only some years ago. In the period
following the Great Recession, central banks and governments
confronted a demand deficit and persistently low, below-target
inflation. The opposite is true today. There is now a supply
deficit. And correspondingly high, above-target inflation around
the world, including in the United States and Canada.

Global supply was slow to adjust through the recovery to the
rebound of demand. Supply chains were disrupted by lockdowns,
worker absenteeism, and logistical challenges. Commodity prices
trended upward, and then were pushed far higher by the effects of
the war in Ukraine and by sanctions imposed on Russia. This
contributed to widespread increases in input costs. Meanwhile,
businesses confronted a fragmentation of the trade rule book
resulting from uncoordinated policy responses to COVID and to the
war, a tense geopolitical environment, heightened strategic rivalry
between the United States and China, and rising protectionism.
Re-shoring of activity also adds to costs. This would be a time for
institutions like the G20 and the World Trade Organization (WTO) to
help. But they are largely missing in action.

Domestic policies also contributed to inflation. Exceptional
monetary and fiscal support was absolutely necesssary to prevent
more serious and lasting damage from the pandemic, but now strong
demand is meeting a supply-constrained world. In the United States
and Canada, there are generalized labour shortages. Wage pressures
are building up. And firms are passing on higher costs for inputs
and labour to consumers. In Canada, buoyant demand for housing,
against a limited supply, has pushed prices to levels that appear
out of reach of a new generation of prospective buyers.

Unfortunately, the policy prescription for correcting the
imbalance between demand and supply is not a pleasant one. Both
fiscal and monetary policies must be oriented towards dampening
domestic demand. Central banks have to raise interest rates in
order to discourage borrowing. Governments have to allow inflated
tax revenue to reduce real income growth, and they must avoid large
discretionary spending to shield consumers from rising prices. Such
shielding, while popular, would shift more of the onus of demand
adjustment to central banks which would then have to increase
interest rates even further. The higher rates would hurt households
(especially those with high mortgage debt) and businesses which
must make investments in productive capacity.

As a large energy and commodity exporter, Canada has the benefit
of some offset to higher input costs. It is earning added income.
Moreover, it can be part of the solution for partners who seek
reliable and responsible supply of energy, grain, critical minerals
and other commodities to reduce their dependence on Russia or other
sources. It matters what we do with the added export revenue. If it
is simply paid out to shareholders, the economic benefit will be
modest and perhaps short-lived. If it is reinvested in productive
capacity, in technology, and in decarbonization, we can strengthen
our long-term prospects.

So there is a fair amount that we know. But that does not tell
us where the economy will go over the next 24 to 36 months. All
will depend on how such factors as the war in Ukraine, the
pandemic, geopolitical conflict, capital markets or consumer and
business expectations will evolve and interact. While the general
prescription of demand restraint is clear, central banks and
governments will have to be prepared to adjust policy in response
to events as they unfold.

In a period of such uncertainty, there is a range of possible
futures that are equally plausible. That makes the business of
planning more difficult. One has to consider more than one
scenario, be ready to capitalize on opportunity, but also be
prepared for adverse events.

To assist businesses in this exercise, we present two scenarios
for the period to 2024, one optimistic, one pessimistic, both
plausible and by no means the end points of what is a wider range
of possible futures.

In the optimistic scenario, global forces and the expectations
of consumers and businesses work in such a way as to facilitate the
balancing of demand and supply. With some monetary policy
tightening to the end of 2022, the U.S. and Canadian economies
manage a soft landing and by mid-2024, inflation is back at 2% and
output is on a trajectory roughly consistent with potential.

In the pessimistic scenario, forces move the other way and hence
central banks have to take more aggressive action. The U.S. economy
goes through a mild recession in 2023 that Canada narrowly escapes.
Both economies still get back on course by the second half of 2024,
but the ride is bumpier.

These two scenarios are simply illustrative, helping to draw out
the interaction of global and domestic factors that will impact
Canadian economic performance to the end of 2024.

As governments and businesses assess these and other scenarios,
and prepare accordingly, there must also be a focus on the longer
term and on investment necessary for a competitive, sustainable
economy. With this economic outlook, we issue four companion
papers—dealing respectively with the trade and investment
environment, commodity markets, the labour market, and digital
money—that help bridge short-term prospects and conditions
for long-term prosperity.

We hope our analyses will be helpful for businesses as they plan
their operations and investments.

David A. Dodge and Serge

Senior Advisors, Bennett Jones

I. Introduction and Executive Summary

A Pandemic, a War, Heightened Uncertainty, and Supply

When the pandemic was declared in March 2020, and
lockdowns were imposed across the major economies, there was high
uncertainty about economic prospects and a policy priority to
support household incomes and business viability through a period
of turbulence.
COVID came after years when policy globally
had been fixated on an aggregate demand deficit, when central banks
struggled to get inflation up to their target range, and when low
borrowing costs pushed asset values higher and encouraged higher
indebtedness of governments, businesses, and households. The
pandemic also struck as major economies confronted a diminishing
social and political consensus over the tenets of sound economic
policy, including growing doubts about an open trade and investment
environment, as well as rising geopolitical tension. For an open,
middle power like Canada, a slow growth, fragmented world was a
difficult backdrop to transform the economy in response to
population ageing, technological disruption, and climate

Over two years later, the economy has rebounded, but
supply remains deficient and inflation has roared back. Moreover,
the world is even more uncertain.
By early this year, with
a recovery well advanced, governments had largely pulled back their
exceptional fiscal aids for households and businesses. For their
part, central banks had laid out plans to halt or reverse
quantitative easing, and had begun to raise policy interest rates
in response to inflationary pressures that were becoming more
widespread, and more persistent, than was thought through the
course of 2021. Overall, advanced economies had solid momentum,
held back principally by supply constraints. Prices in commodity
markets were rising, labour markets were tightening, and global
supply chains and infrastructure, in many cases still affected by
COVID-related disruptions, were failing to keep pace with demand.
In February, the unprovoked invasion of Ukraine by Russia, and the
swift application of sanctions in response, exacerbated global
economic tensions and uncertainty. Today, the world is less safe,
Europe is a divided continent, conflict between the world’s
democracies and authoritarian regimes—in particular between
the United States and China—is acute, COVID is persistent,
and China’s zero-COVID policy is forcing extended lockdowns.
Meanwhile, global problems like climate change are still in search
of collaborative solutions.

In this environment, policy authorities in the United
States, Europe, Asia, and Canada have to be responsive to a wide
range of possible global developments, while also addressing
distinct domestic circumstances, as they aim to bring supply and
demand into better balance.
With perfect hindsight, there
is wide recognition that while aggressive monetary easing in 2020
was absolutely required to contain damage from the pandemic, the
Federal Reserve and the Bank of Canada could have acted sooner in
2021 to begin normalizing monetary conditions and prevent
overheating of the economy. With inflation, including core
inflation, now persistent and well above their targets, the Federal
Reserve and the Bank of Canada have to “catch-up”. They
have a difficult balancing act: moving fast and strongly enough to
stem inflationary pressures earliest, but not too fast or too
strongly such as to provoke a recession. The European Central Bank,
amid different circumstances, has to achieve an equally delicate
balance. Similarly, governments have to continue the shift away
from policies that are stimulating demand. Fiscal action through
the pandemic in the United States and Canada, while appropriate,
likely exceeded the needs of the economy—witness the higher
than pre-pandemic levels of household disposable income and the
large accumulated savings from the second quarter of 2020 onwards.
The larger fiscal revenue now earned by federal and provincial
governments in Canada, together with the close to complete
withdrawal of exceptional aids, is helping to moderate demand.
There is a need for ongoing, careful calibration of fiscal policy
to ensure that it is working in tandem with monetary policy.

Likewise, the planning environment for businesses is one
of heightened uncertainty and complexity.
Most industries
have now recovered fully from the pandemic. Some, like digital
technology or finance and professional services, sailed through it
comfortably. For the energy and commodity sectors, the recovery has
been robust as prices rose sharply from their lows in April 2020,
and then spiked further as the invasion of Ukraine and sanctions
against Russia caused widespread disruptions in the supplies of key
commodities and the normal patterns of trade. Looking ahead, as
businesses contemplate investments in productive capacity, they see
global tensions, fragmentation—and disregard by some—of
the trade rule book, rising interest rates, labour shortages, and
risks of recession. In the capital markets, after years of
virtually uninterrupted increase in the value of shares, bonds, and
real property, with also a phenomenal expansion of cyber-assets
with often nothing behind them but their novelty, investors have
turned bearish and more risk averse. Housing, particularly in
Canada, is also vulnerable: while demand is robust, and supply is
constrained, rising interest rates and high household indebtedness
should moderate if not disrupt current price trends. Yet, while
some trends and signals are preoccupying for businesses, Canada
desperately needs business investment, in particular
non-residential investment, to sustain and to grow productive
capacity and for our industries to be positioned for long-term

The Factors that Will Shape Economic Outcomes to

Looking ahead, the outlook for growth, inflation and
interest rates, and the path for demand and supply to come into
better balance, are highly uncertain, both globally and here in
Forecasting is an imprecise science at the best of
times but when there are multiple sources of uncertainty, and thus
multiple combinations of potential outcomes, it must be approached
with particular caution. Governments and businesses have to be
ready for a range of scenarios. It does not suffice, and may be
seriously misguided, to plan strictly on the basis of one set of
assumptions. Where there is excess demand, normal market
mechanisms, for example higher prices, should help restore balance
over time. But events can disrupt the normal adjustment, and policy
must then react to ensure that demand and supply are on a path of
convergence. Businesses thus must be alert to the events, the
adjustment process, and the policy responses.

What will determine the course of the U.S. and Canadian
economies over the next 24 months is the evolution of a set of
structural and policy factors, each difficult to predict
individually and each interacting with others in complex
For Canada, much will be defined by global events
and by the economic policy responses of our global partners,
especially the decisions of the Federal Reserve. Governments and
the Bank of Canada will have to navigate amid this evolving
environment that may push our economy toward either a soft landing
or a more abrupt adjustment.

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The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

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