Rate hikes are the wrong way to address this round of inflation

Apparently, there are some in Ottawa who think inducing a recession by setting an ever-higher policy interest rate is the most effective way to reduce the current rate of inflation. If this were a competition, such an approach would take the cake as stupid economic strategy.

A lot of the current high rate of inflation is the result of a sluggish response to increased demand. As production expands, the rate of future price increases will taper off automatically. That said, it is unlikely there will be a return to the Bank of Canada’s 2% annual rate inflation target this year under any likely scenario.

One of the consequences of the COVID-19 pandemic was that discretionary expenditures by Canadians were sharply reduced. Going out for meals or attending public events just was not an option pre-vaccine. Gatherings were limited in size — if not outright banned. As a consequence, consumers’ bank deposits rose to record levels. True, some who lost their jobs suffered financially, but the majority of our fellow citizens accumulated record cash in their deposit accounts and near-cash investments.

It is those deposits and current pent-up, temporarily-inflated demand, while goods production and imports are recovering only slowly and output lags, that are fuelling price increases. Add to that the impact of increasing energy prices on the costs of distribution and it is no wonder inflation took off at a rapid rate.

So, what has government done and what more could it do to help the economy return to a more normal and balanced state?

First, the Bank of Canada is allowing interest rates to rise. If people were borrowing to consume, raising the cost of borrowing would make sense. But currently, consumer borrowing is far from a booming market. Of course, rate increases have an impact on loans that are subject to a market rate.

For people with variable-rate mortgages, particularly mortgages taken out recently to finance exorbitant housing purchases, the increases really put their feet to the fire and may ease pressure on housing prices.

But overall, rate increases will have modest effects — save for making people more aware of inflation and probably jacking up earnings of the financial sector.

What is really needed is some way of soaking up some of the cash hoards held by consumers, while at the same time providing aid to the lowest income earners to offset the negative impacts of high inflation.

To reduce consumers’ free cash, the federal government could simply restore the cut to the rate of the GST from 7% to 5 % made by the Harper government. That would bring in several billions in additional revenues, with all of this windfall going to reducing the deficit. Conservatives should love such a measure.

Providing aid to the less flush can be easily accomplished by jacking up Old Age Security payments to those elders with low gross wage and other income. (Net taxable income is not a good gauge of need because many wealthy retirees can use all sorts of loopholes to minimize tax and they should not benefit from such a policy.)

For younger people who are not on a fixed income or retired, a tax cut — again similar in structure — could be implemented by direct payment or elimination of taxes.

The critical thing, however, is to stop relying solely on monetary policy to rein in inflation and start using fiscal policy to deal with this transitory problem.

Government could get realistic about its expenditures, both by eliminating tax expenditures that primarily benefit the wealthiest people and by being more disciplined in its budgeting.

One example would be concentrating the Department of Defence’s expenditures on building ships rather than buying 80 or more F-35 fighter planes at more than $113 million-plus a pop and more than $45,000 an hour to operate. We are, after all, bounded by three oceans and are unlikely to experience a land invasion from the south. We won’t have more jet jockeys but we could have a much larger transport and helicopter capacity for the fewer dollars.

No recession ever yields net gains for the national economy, and those who believe it could are out to lunch.