Governor Tiff Macklem discusses the relationship between inflation and employment and how the Bank of Canada is working to cool an overheated economy.

Watch Governor Macklem speak to the Public Policy Forum. Read the full speech.

Inflation and employment are linked

The best contribution the Bank of Canada can make to the well-being of Canadians is to keep prices low and stable. That’s because inflation that is near our 2% target and what economists call “maximum sustainable employment” are strongly connected.

When employment is far below its maximum sustainable level, workers can’t find jobs and see their earnings decline. This affects spending, pushing inflation below our target. That’s what happened early in the pandemic.

When the economy is operating above maximum sustainable employment, businesses can’t find enough workers to keep up with demand. As a result, prices go up and inflation rises. That’s where we are today.

Learn more about how the Bank’s monetary policy works

The pandemic created turmoil in the jobs market

The COVID‑19 pandemic impacted the labour market in three phases:

  1. The shock of pandemic shutdowns plunged us into the deepest recession on record. Millions lost their jobs or saw their hours cut. Those working in the services sector were hit especially hard.
  2. The recovery that came with re-opening was swift and robust. The supports that governments offered played a big role in keeping workers attached to their employers and businesses afloat. The Bank also cut interest rates and introduced quantitative easing to reduce borrowing costs. This supported spending.
  3. The current environment of excess demand means the economy’s need for labour is greater than its ability to supply it. The Bank began raising interest rates in March to cool this overheated economy.

We’re trying to balance the risks of over- and under-tightening monetary policy. If we don’t raise interest rates enough, Canadians will continue to endure high inflation, and high inflation will become entrenched, requiring much higher interest rates and a sharper slowing in the economy to restore price stability. If we raise interest rates too much, the economy will slow more than it needs to, unemployment will rise considerably, and inflation will undershoot our target.”

Price stability and a healthy labour market go hand in hand

Achieving better balance in the labour market involves two elements—supply and demand:

  • Demand is what the Bank influences with interest rate increases. Our analysis suggests that because the labour market is hot and we have a high number of vacant jobs, we can afford to cool the economy without causing the surge in unemployment that we experienced in previous recessions.
  • Supply can’t be influenced by the Bank’s policy tools. Governments, businesses and workers all have a role to play in boosting the supply of labour so we can grow the economy sustainably - without creating inflationary pressures. More immigration, better training and expanding the workforce through digitalization and flexibility can help achieve this. But enhancing supply takes time. It also creates new demand. Increasing supply, while valuable, is not a substitute for using monetary policy to curb spending and restore price stability.

That’s why we have front-loaded our interest rate increases. And that’s why we are resolute in our commitment to return inflation to the 2% target. To get there, we need to rebalance the labour market. This will be a difficult adjustment. We want to do this in the best way possible for Canadian workers and businesses.”

Watch Governor Macklem answer questions from the media following his speech.

Read the full speech.

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Topic(s): Central bank research, Coronavirus disease (COVID-19), Domestic demand and components, Expectations, Inflation and prices, Interest rates, Labour markets, Monetary policy, Monetary policy framework, Potential output, Price stability, Productivity, Recent economic and financial developments

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