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 hazardous

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 Dupont

Senior Advisors, Bennett Jones

I. Introduction and Executive Summary

A Pandemic, a War, Heightened Uncertainty, and Supply Gaps

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 change.

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 success.

The Factors that Will Shape Economic Outcomes to 2024

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 Canada. 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 ways. 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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