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The major Canadian economic release today was the Consumer Price Index (CPI) for March. Inflation, as measured by the year-over-year change in the CPI, dropped sharply from 2.2 percent in February to 0.9 percent in March, as the economic disruption from COVID-19 hit. Removing seasonal effects, the CPI fell 0.9 percent in the month of March—the largest monthly decline on record.
Lower energy prices were a big part of the story. Energy prices fell 11.6 percent year-over-year, led by a 21.2 percent decline in gasoline prices—no surprise to anyone that filled up their car last month.
The impact of the pandemic and efforts at social distancing were evident. Prices for traveler accommodation, rental of passenger vehicles, and intercity transportation (rail, highway bus, etc.) all declined significantly. Travel tour and air transportation prices were still up in year-over-year terms, but rose slower on a monthly basis.
As we think about the outlook, a common question I receive is whether all of the monetary and fiscal policy actions will lead to a major inflation problem? In my opinion, the major risk at the moment is the possibility that deflation will take hold.
Even with the massive policy response, we are still going to have significantly higher unemployment and many Canadians will experience a negative shock to their income. Moreover, there is a negative wealth effect on households from the decline in stock prices. Statistical analysis suggests that for every $1 of losses in equities there is a 2-3 cent decline in spending. As this tempers consumer spending, there is the possibility that businesses will provide price discounts in an effort to collect revenues and ease cash flow strains.
All of this can lead to lower inflation and risks of deflation. Deflation must be avoided at all costs, because if it takes hold, it becomes very difficult to escape. Deflation is economically toxic, because why buy today what will be cheaper tomorrow? And, that is why we have the unprecedented amount of monetary and fiscal stimulus being deployed and why I am not expecting an inflation problem in 2020 or 2021.
However, the inflation risks could increase if we take a much longer view. A strong economic recovery combined with continued policy stimulus could lead to inflationary pressures. However, I think the risks of this are low, since I believe the economic recovery will be very slow. I believe there will be many legacies from the Great Lockdown of 2020 that will be a headwind on growth. For example, we will have more indebted households, more indebted businesses, and dramatically more indebted governments. This is a hurdle for future economic growth.
On the real estate front, we are getting early evidence of the fallout from the lockdown. Toronto home sales tumbled 69 percent in the first half of April. Reduced supply (a 64 percent decline in listings) tempered the price effect, with prices declining 1.5 percent in April 2020 from a year earlier.
Equity markets rallied today on news that the U.S. Senate passed another $484 billion infusion for its small business aid program, coronavirus testing, and hospital support package. The House of Representatives is expected to vote later this week on the stimulus. President Donald Trump has already suggested he would sign the bill once it arrives at his desk. The funds add to the $2.2 trillion relief package Congress initially passed in late March.
As mentioned in a prior daily note, the policy discussions switched in recent weeks from how to respond to the crisis, to how to reopen the economy. And, with the health statistics improving, some provinces are laying out their thinking or plans. PEI announced its "Re-opening PEI, together" plan, using a phased-in approach to ease back on public health measures. This could begin as early as May 1. Saskatchewan Premier Scott Moe is also set to announce the "Re-Open Saskatchewan Plan" tomorrow, which will outline their framework for gradually re-opening the economy.
On the federal front, the Government of Canada announced a new benefit of $1,250 a month for students and recent graduates that will run from May to August to address the shortage of summer jobs due to COVID-19. Moreover, for students who choose to do national service and serve their communities, there is a new Canada Student Service Grant that will provide up to $5,000 for further education.
The income support for students is welcome, but it will be important to address youth unemployment as the recovery takes hold. There is considerable evidence that youths that graduate and enter the labour market during a recession have their career paths set back, and in many cases the effect lasts decades after the recovery has taken place.