In today’s speech, Deputy Governor Larry Schembri explored the impact of the pandemic on Canada’s labour market. Specifically, he aimed to shed light on the question of how monetary policy can adapt and promote an inclusive recovery. To answer this question, Deputy Governor Schembri looked at two labour market uncertainties: the maximum level of sustainable employment and the relationship between labour market tightness and inflation.
On the maximum level of sustainable employment, Deputy Governor Larry Schembri clarified that this concept refers to “the highest level of employment that the economy can sustain without triggering inflationary pressure”. Structural changes such as an aging population, immigration, globalization, and technological change can all impact the maximum level. With COVID-19 accelerating some pre-pandemic trends, and upending others, it’s become harder to assess the overall state of employment and capacity pressures. Next, on the relationship between labour market tightness and inflation, also known as the Phillips curve, Deputy Governor Schembri explained that the association has become weaker and more difficult to measure, and that this is closely related to the fact that the maximum level of employment is also now more uncertain.
To better understand labour market conditions in the conduct of monetary policy, the Bank is looking at a broad set of labour market indicators. The Bank has developed a “three-dimensional” approach to assess labour market performance. The first is a set of overall labour market indicators, the second consists of variables that measure labour market inclusivity, and the third incorporates indicators of job characteristics. Using this approach, the Bank found that the labour market has improved significantly since the start of the pandemic, but there are still areas of slack, particularly among older workers and individuals that have been unemployed over a longer term. In addition, wage growth is also muted.
Deputy Governor Larry Schembri said the comprehensive approach to assessing labour market conditions will have important benefits for monetary policy. However, there is still much uncertainty around when excess slack in the economy will be absorbed. The Bank communicated in October that it will be sometime in mid-2022.
Key Implications
Deputy Governor Larry Schembri took time today to highlight that there is an abundance of uncertainty right now in Canada’s labour market and that it has made the conduct of monetary policy challenging. Important macroeconomic variables such as the maximum level of employment are considerably more uncertain now, so the Bank will have to pay close attention to a wide range of indicators as it charts the next steps for monetary policy.
In essence, today’s speech points to a more reactionary central bank. As the data evolve, the Bank of Canada will be prepared to shift guidance accordingly. This was a sentiment also expressed by Governor Tiff Macklem in an article released yesterday, where he emphasized that monetary policy will adjust to unexpected shocks to its narrative. Indeed, the future of monetary policy is not set in stone, and this week’s Bank of Canada communication underlines that point.
