The platypus economy
From the February 2023 print edition
If you’re a baby boomer (which means you were born between 1946 and 1964) you may be familiar with the book, Zen and the Art of Motorcycle Maintenance, by Robert Pirsig. It’s a great work, but in my opinion his second novel, Lila, is even better. In it, he discusses the inability of traditional thinking to place the animal, platypus, into the conventional categories understood by zoologists.
Specifically, mammals suckle their young while reptiles lay eggs. But low and behold, the platypus lays eggs and then after those eggs are hatched, it suckles its babies. So, what is a platypus? A reptile
or a mammal?
Apparently, this question created quite a stir in the zoological community. What a paradox! But as Pirsig points out commonsensically, there really isn’t any paradox. Platypuses are doing what is natural for them, what they’ve been doing for thousands of years. The real mystery – and here I’m using Pirsig’s words verbatim – “is how mature, objective, trained scientific observers can blame their own goof on a poor, innocent platypus.”
This story came to mind in the wake of the Bank of Canada’s decision on January 26 to raise interest rates for the eighth time in the past 12 months. What it is responding to is an economy that it believes has systemic inflation built into it. Raising interest rates is the traditional response that central banks all over the world have used when they believe there is an inflationary spiral. Except the Bank of Canada is missing the point. We are not in an inflationary spiral and the inappropriate response of hiking interest rates is almost certainly going to lead to a prolonged period of slower economic growth than is necessary.
My guess is that if you studied macroeconomics either in high school or university, you learned about the business cycle. The core of this theory is that in the developed world, the economy tends to grow over time, but not in a linear manner. There are extended periods of expansion, then contractions, before the recovery and subsequent re-expansion.
The two most important indicators to determine where we are at any one time in the business cycle are inflation and the unemployment rate. And this is why today’s central bankers are raising interest rates: inflation is higher than the desired two per cent and unemployment is extremely low. It currently stands at five per cent while the historical norm is 7.6 per cent.
A different economy
But here’s the rub. Today’s modern economy is fundamentally different than it was when the current theories were developed. Specifically, manufacturing is not as important as the service sector, which is far less cyclical.
Think of the most important services that you use routinely, health and dental care; or basic government services like getting your driver’s license renewed or mail delivery. These are not cyclical. I would agree that if this were the 1970s and the indicators were pointing in a similar direction, then the appropriate response would be to raise interest rates. But things are different now, and when things are different, they are not the same.
If the Bank of Canada is incapable of reading the economy correctly, at least we can. I’m looking at a graph of the price of oil and a barrel is pretty much identical to what it was one year ago. At the same time, it’s significantly lower than it was from an extended period that stretches from March to August 2022. When the inflation numbers come out several months from now, we’re almost certainly going to see readings that are either benign or even disinflation which means lower prices compared to a year before.
And we have to correctly understand the unemployment rate. Yes, unemployment stands at five per cent which is about 2.5 per cent lower than the historical norm.
But as of December 2022, the participation rate was 65 per cent. The participation rate measures the percentage of the working age population that is either working or actively looking for work. Historically, it has been about 67 per cent and if you adjust for that, you immediately understand that the unemployment rate is pretty much even with its historical norm.
I read the news every day and one large organization after another is slashing its work force. This suggests that this is not the time to be hiking interest rates.
So why are interest rates going up? A critical reason is that those who make these decisions are themselves exempt from experiencing the real economy. Tiff Macklem is the Governor of the Bank of Canada. He earns approximately $500,000 per year. My guess is that he’s not carrying a mortgage. He and the other decision makers are so out of touch with the reality of most Canadians that we can’t reasonably expect them to craft sound economic policy. Which is why they don’t.