Stagflation, Here We Come!

Stagflation refers to both rising unemployment rates and rising rates of inflation. It occurs only when the short-run Phillips Curve shifts to the right. We had a serious case of it during the late 1970s and early 1980s, and we are going to experience it again, but probably just to some minor extent, over the next year or so.

The unemployment rate in Canada is at a 30-year low. At 6.6%, the unemployment rate is well below the natural unemployment rate (roughly between 7 and 7.5% in Canada) and is bound to rise as people's job search expectations adjust to the new reality.

Meanwhile, the growing aggregate demand that has heated up the Canadian economy will continue to put upward pressure on the rate of inflation. The money supply in Canada has been growing by nearly 10% per year for quite some time; eventually all that liquidity will lead to growing pressure on aggregate demand and, in turn, on prices.

Sure, the Bank of Canada is trying to reduce the inflationary pressure, but they do not want to put the brakes on too hard. The result will be a gradual slowing over the next year and a half, but with the rate of inflation growing until the tighter monetary policy takes hold.

Also, see Steve Poloz' column about stagflation.

topic: Economics