Absence of wage pressures means Bank of Canada will let economy run

TORONTO, Nov. 7, 2013 /CNW/ - Demographic and policy changes mean Canada's unemployment rate has room to drop much further before we'll see pressure on wages that could trigger inflation, finds a new report from CIBC World Markets Inc.

The report notes that historically, today's 6.9 per cent unemployment rate would already be generating wage and price pressures. In both 1999 and 2005, the Bank of Canada declared the economy had exhausted economic slack and reached full employment at essentially the very same jobless rate. In both cases, the Bank raised interest rates to cool the country's overheating economy.

"But full employment ain't what it used to be, and that's good news for job seekers," says Avery Shenfeld, Chief Economist at CIBC. "Demographic and public policy changes in recent years have lowered the non-inflationary rate of unemployment. That will allow the Bank of Canada to keep rates low for long, and press ahead towards further labour market improvements."

Mr. Shenfeld notes that, unlike the U.S., where millions of discouraged workers have given up searching for work and no longer count among the unemployed, discouraged workers excluded from the jobless count represent only 0.1 per cent of Canada's working-age population. Those saying they want work but aren't in the labour force represent the same 2 per cent share that they did when the output gap was zero in 2005.

While the participation rate has dropped, he adds that's solely due to shifting demographics, as a greater share of the population reaches retirement age. If the population shares of each age cohort are held constant, the participation rate would have been rising since the recession, as other than youth, each demographic group's participation rate has been steady or rising.

"Underemployment is, however, a factor that has led to an understatement of labour market slack relative to the past cycle," says Mr. Shenfeld. "There are close to 900,000 Canadians working part-time because that's all they can get, rather than by choice. That's a half-percentage-point larger as a share of the workforce than when the economy had full employment in 2005. The additional hours they could offer up provides a cushion against wage and price pressures."

Canada's degree of "frictional unemployment", the inevitable share of the labour market that will, even in a healthy economy, be between jobs or looking for their first job at any point in time, is also contributing to a lower jobless rate. This unemployment category has been in decline and the rate is already lower than at points in 1999 and 2005 when the output gap was zero.

Changes in government policy are a factor in the reduced level of frictional unemployment. "New immigration rules are focussed on tilting the mix of new Canadians towards those with targeted skills and stronger language proficiency," notes Mr. Shenfeld. "Those coming in under the Provincial Nominee Program, focussed largely on job-ready individuals who cross the border with a job offer in hand, represent 13 per cent of new permanent residents, up from only 2 per cent in 2005.

Tighter rules for unemployment eligibility now require Canadians to accept a wider range of employment offers rather than continue to search for a job that's either higher paying or closer to home. EI recipients now represent 37 per cent of unemployed in Canada, down from 51 per cent in 2009 and an average of 47 per cent in the ten years prior to the last recession.

Mr. Shenfeld also suspects declining unionization coverage could also be a modest factor by reducing worker bargaining power, particularly as Canadian workers now compete with "right to work" states south of the border. He notes that this could reduce the wage inflation pace at any given level of unemployment.

"All of this implies that the labour market has more room to run to lower unemployment rates before wage pressures threaten the Bank of Canada's 2 per cent CPI target. Add to that some other factors putting downward pressure on CPI and there are reasons for the Bank of Canada to eschew rate hikes until early 2015.

"By that point, we expect Canada's unemployment rate to be in the vicinity of 6.2 per cent, well below what had previously been the Bank of Canada's comfort zone."

The complete CIBC World Markets report is available at: http://research.cibcwm.com/economic_public/download/einov13.pdf.

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SOURCE CIBC