As central bankers move aggressively to combat inflation, new research published by the Bank of Canada warns that past recessions have been followed by increases in income inequality.
In a new staff discussion paper, researchers find that income inequality in Canada has been relatively stable over the past 25 years, but that Canada experienced significant increases in inequality during the 1980s and in the first half of the 1990s amid the recessions that occurred during those eras.
“While many factors were at play over these periods, monetary policy actions to bring excessive inflation under control and to limit a further buildup of economic vulnerabilities partly played a role in these recessions,” the paper noted.
These economic downturns led to increased inequality as the incomes of low earners were “particularly hard hit” during those recessions and didn’t recover — whereas the incomes of high earners “recovered quickly” and then continued to rise, the research found.
Over the past 25 years, however, income inequality has improved.
The paper cited Canada’s progressive income tax system and government transfers to households as factors that have reduced inequality generally, and limited its increase in more recent recessions.
Nevertheless, concerns about the risk of increased inequality remain, particularly in the wake of the pandemic, which disproportionately harmed women and lower-income workers.
Now, as monetary conditions tighten, policymakers concerns about rising inequality may resurface too — particularly as policy actions during the pandemic may have boosted the economy “in a way that benefited the wealthy the most.”
“The combination of the devastating destruction of livelihoods for many across the globe with the rising fortunes of a few has fuelled a more profound concern,” the paper warned.
“This concern focuses on the adverse effects of inequality not only on the health and happiness of individuals but also on social cohesion and trust in the institutions that serve a country’s citizens,” it said. “Research has shown that economic growth and stability are adversely affected when inequality rises.”
How likely is a slump?
In a research note, William Robson of the C.D. Howe Institute examined the potential for recession to precede a drop in inflation.
“Just as it takes an economy running hot to push inflation up, it takes an economy running cold to push inflation down,” Robson observed. This occurred before sudden drops in inflation in 1976, 1983 and 1992, when the consumer price index fell by more than 4.5 percentage points. (Such a drop will be necessary to hit 2% inflation in late 2024, as forecast by the Bank of Canada in its latest monetary policy report.)
If a slump occurs in the near term, however, Robson said it could be less severe than on the previous occasions for three reasons: an improving global economy as supply shocks lessen and central banks unwind “monetary and fiscal excesses”; improved education on the relationship between monetary policy and inflation; and increased expectations of a downturn.
“If a dimmer outlook induces more caution across the board, the Bank of Canada’s upcoming interest rate increases will be smaller, and the cycle will end sooner,” Robson said.