Canadian recessions 101: They’re usually caused by events in the United States

Recent poll finds most Canadians believe the country is headed for another decline

The central bank has consistently underestimated inflation levels in 2022, and its critics argue it will push the economy to the brink through its aggressive rate hikes

It’s been more than a decade since the word “recession” has been uttered so frequently at Canadian dinner tables.

Not since the financial crisis of 2007 has the threat of a major economic downturn been as talked about as the situation now facing Canadians, who are emerging from a COVID-19 pandemic that saw record amounts of stimulus injected into the economy, only to have a war in Ukraine and the subsequent sanctions against Russian oil send energy prices into a tailwind.

With inflation reaching 7.7 per cent in May — its highest level since 1983 — the Bank of Canada is racing to increase interest rates, with the sole goal of getting inflation back to its target of two per cent.

The central bank has consistently underestimated inflation levels in 2022, and its critics argue it will push the economy to the brink through its aggressive rate hikes.

While the central bank said it intends to engineer a soft landing — one where rising interest rates do not entirely derail the economy — the fear of a possible recession in the next two years is growing.

According to a new survey from Yahoo Canada/Maru Public Opinion, 68 per cent of Canadians believe the country is heading toward a recession, while 17 per cent believe it has already arrived.

“We know that the Bank of Canada can generate a recession,” said Wilfrid Laurier University economist David Johnson, a former central bank employee. “It hasn’t done it very often. Usually, it is caused by factors outside of Canada, but it is possible.”

With the rapid increase in interest rates, said Johnson, the hope is that a reduction in new home building will be enough to raise the unemployment rate back to its usual level, and the country will be able to avoid a downturn. But that’s a big if, and the Canadian economy will also have to rely on the U.S. economy finding a similar landing.

The technical definition of a recession is when output, or gross domestic product, declines for a certain period, Johnson said. Many economists consider six consecutive months as the golden rule, but there is no general consensus on the length.

Another recession indicator is when there is a decline in production across a fairly large number of sectors at the same time.

Economists may also consider

unemployment data, with the expectation that a recession brings higher levels of unemployment.

So, why does this happen? “Typically, there is an event in the economy that happens so that there is a reduction in demand for some significant quantity of production, and that then creates a shock wave that moves through the economy.”

In Canada, said Johnson, this usually occurs when there is less demand for its exports to the United States, which receives about a third of Canada’s production. Whether it is commodities, automobiles, or American tourists coming for vacation, Canada is closely linked to the U.S., and right in the middle of its supply chain.

When there is a recession in Canada, said Johnson, the usual reason is there is a recession in the U.S.

There is an example in history when the Canadian central bank raised its interest rates higher than its U.S. counterparts to try to reduce demand to reduce inflation — this happened in 1990 and 1991. This was one of the rare cases when the country had a recession created within Canada, said Johnson.

Canada has had a total of 13 recessions since 1929, with six coming since 1970. While each situation is different, recessions typically last between three and nine months. Canada’s recession in 2008, for example, lasted about seven months.

In Canada, a team of economists at the C.D. Howe Institute are tasked with trying to identify recessions through the data. That team declared Canada was in a recession in May 2020 due to the impact of the COVID-19 pandemic.

But it’s not always the easiest work to do, said Johnson.

The challenge with trying to understand recessions, he said, is that normally when demand for something falls, you would expect prices to fall. But in general, he said, prices don’t tend to decline very rapidly in these scenarios, and it’s something that economists still do not fully understand.

“We don’t really have a full understanding of why when the demand for everything falls, prices don’t just fall and demand increases again,” he said.

“People just seem to be hesitant to reduce the prices of things. They’re also hesitant to increase prices, but certainly not as hesitant.”

Economists also don’t fully understand why wages don’t similarly fall during these down periods, he said, which would also likely help in shortening the length of a recessions.

So, with prices and wages not changing, how do recessions typically end?

In general, recessions end in Canada when the event that caused the initial shock has ended. More times than not, said Johnson, that just means the recession in the U.S. has ended.

Sometimes, this can be helped by the Canadian central bank lowering its interest rates to drum up demand in the economy again. This is what happened in 2008, which led to more than a decade of low interest rates.

Governments can also increase spending to try to increase demand during these periods as well. In 2008, for example, the federal government introduced the home renovation tax credit to subsidize home renovations.

But in the grand scheme of things, a country with a population of 38 million in a world with over seven billion people is largely at the mercy of global economics.

While Canada can put in safeguards to limit recessions and their impacts, said Johnson, it is unrealistic to think it can avoid them altogether.

“If the rest of the world decides that for whatever reason they are not going to buy the things that we export, then we are very likely going to have some kind of recession, and that has been the pattern of Canadian economics since Canada has been integrated into the world economy.”