Why the Bank of Canada wants you to take a (real) pay cut

The Bank believes real wages are too high to sustain a significant recovery

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The Canadian dollar has depreciated by more than six per cent against the US dollar since the Bank of Canada dropped its tightening bias in October. The CAD may continue to depreciate, or it may not: changes in exchange rates are notoriously difficult to predict. The Bank of Canada is presumably not displeased with this development. Lower exchange rates—and lower long-term interest rates—are what you’d expect from a softening of its stance.

But what about the rest of us? Exporters—especially those whose sales are priced in US dollars—will see an increase in revenues. On the other hand, consumers are made worse off by the higher cost of imports—and consumer welfare is what really matters. Why would the Bank of Canada want to reduce Canadians’ purchasing power?

The answer is that the Bank probably believes that real wages are too high to sustain a significant recovery. A recent Econowatch post noted that real wages had increased significantly over the past 18 months or so:

This increase isn’t due to a surge in the demand for labour so much as the fact that inflation has been low: year-over-year CPI inflation has been below the Bank of Canada’s 2 per cent target for the past 18 months. It’s not a coincidence that the increase in real wages that started in mid-2012 coincided with the drop in inflation.

Nor is it likely a coincidence that the disinflation-induced rise in real wages began roughly when the employment recovery lost momentum:

(I’m using the prime-age employment rate for reasons I explain in this recent Econowatch post.)

As far as the the Bank of Canada is concerned, low inflation is a problem in itself: it has a mandate to keep inflation at or near 2 per cent. It’s harder to make the case that high real wages are a problem for the rest of us.

It’s useful to look at it as a coordination problem. We may all believe that a more rapid rate of job creation would be a good thing, and that high real wages are an obstacle to faster employment growth. But each of us also knows that it doesn’t make any sense to volunteer for a wage cut: one worker’s wage won’t affect the average. Engineering an economy-wide wage reduction would be a protracted exercise in waiting for someone else to go first.

An exchange rate depreciation is a far simpler way of reducing wages across the board, and the ability to do so is one of the strongest arguments for maintaining a policy of flexible exchange rates. Economies that have fixed exchange rates —such as the members of the Eurozone—have a much more difficult time of it. Spain is an instructive example. Spanish wages were driven up during its pre-crisis real estate boom and labour costs have remained high. If Spain still had its own currency, reducing wage costs could be achieved quickly by means of an exchange rate depreciation. Instead, Spanish workers are obliged to deal with the long, slow grind of high unemployment and wage concessions.

In this context, the depreciation of the Canadian dollar can be viewed as good news: it is better to have a currency that can depreciate fairly rapidly when real wages are too high. But the fact that we are obliged to reduce real wages in the first place can hardly be viewed as a positive development.

 




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Why the Bank of Canada wants you to take a (real) pay cut

  1. It has been interesting reading the various takes on the rapid decline of the $CDN against almost all other currencies. Your colleague Mike Moffat appears to have nailed himself on the top of the fence out of fear of falling on the wrong side like, say, Alan Greenspan.

    I’m no economist, but I do like the whimsical Big Mac Index.

    The best way to determine if the value of the $CDN is fair is to travel. If all you can afford is a Big Mac because the restaurants favoured by the locals are too expensive, and then the cost of that Big Mac is outrageous compared to home, then your currency is undervalued. It was certainly like that in Norway.

    I lived in London for almost a year back in 2004. A £ cost $2.40 CDN. A € was $1.60 CDN; a $US was $1.35 CDN We travelled a bit and I could not believe how expensive it was. It felt like we were from a 3rd world country. I saw a single car garage sold in London for the same price as my home in Calgary was worth at the time, which had a slightly larger garage and included a 1000 sq, ft. bungalow on a 6000 sq. ft. plot of land with huge trees 4 km from city centre.

    Things change of course. We recently sold a condo in Calgary and bought one in the Netherlands. It was a much better value. As are things like milk, eggs, butter, cell phones, internet and bank fees.

    We don’t have a car; don’t need one. The bike paths here are real bike paths. Almost nobody wears a helmet here because bike lanes are separated from car lanes and the drivers here have to be more aware of others or they pay the price. Public transit here also works. The trains run on time. In Calgary, the bus schedule is only an +/- ½ approximation of when it might appear. The Calgary CTS internet site is straight out of the ’90′s.

    As I write this, it now costs $1.50 CDN to buy a €; $1.80 CDN to buy a £; $1.10 CND to buy a $USD.

    So I’m in agreement with you on this one (whoa!). The depreciation of the $CDN can be viewed in a positive light, but the reality is that it reduces real wages for all Canadians with respect to the rest of the world. And it diminishes the Return On Investment (ROI) in Canada on upgrading technology and productivity because it is now more expensive and simply not worth the price.

    • Its actually worse. Not only did the CAD fall too the USD, the USD fell also to the Yuan, which compounds to CAD. We lost 9% value in CAD, for 9.9% less value money, but if you compare it to Yuan its even worse.

      Yuan is now the largest world currency in value, USA lost that position last year:

      http://www.xe.com/currencycharts/?from=USD&to=CNY&view=10Y

      http://www.xe.com/currencycharts/?from=CAD&to=CNY&view=2Y

      Depreciating money fraud to keep the illusion of big fat debt fraud governments. Many blame the Chinese, but the reality is when someone creates trillions of no value money, the value of money declines. Low rates mean no legitimate lenders are buying governemtn debt for a negative value return, government quite litters electronically counterfeits currency to give the illusion of solvency.

      On this policy of ponzi fraud debt, the eventual value of CAD money is zero. Its why banks will not pay you to have it.

  2. The working poor and seniors on fixed incomes sure need higher prices. The super rich. politicians, banks, businesses and unions responsible for this are all a**holes who really don’t care about the majority — especially the super rich.

    Fewer than a hundred of the richest people worldwide have the same wealth as 3.5 billion of the poorest globally, a report claims.

    Research released by charity Oxfam in a new report titled “Working for the Few” released Monday states that the world’s 85 wealthiest — including telecommunications mogul Carlos Slim Helu, Bill Gates and Larry Page — are worth a collective $1.7 trillion. In comparison, this amount is owned by half of the world’s poorest people, a total of roughly 3.5 billion, says a story in SmartPlanet.com.

    The global aid organization warned that such disparity in wealth distribution may pose risks to “human progress,” and “this massive concentration of economic resources in the hands of fewer people presents a significant threat to inclusive political and economic systems.”

    “Instead of moving forward together, people are increasingly separated by economic and political power, inevitably heightening social tensions and increasing the risk of societal breakdown,” the report says.

    The report comes ahead of the World Economic Forum in Davos later this week, where political and business figures will meet to discuss disparities in wealth and income, healthcare and climate change.

    • Poor seniors receive inflation-indexed government income supplements.

      The rest was just a bunch of yammering about wealth inequality.

      • Not really as you imply. CPP raise last year was 1%. Devaluation of money is 9.9% in CAD money (1.00 / .91 = 9.9%).

        To add insult, you pay taxes on the 1% at top rate as the tax tables don’t keep up.

        So in fact, seniors on CPP got whacked by 9% or more on CPP. Similar on the values of their other savings, investments and pensions. I see your average senior spending a lot less on other peoples jobs.

        The real winners are government politicians and unions, as they get seniors, disabled and others to do with less and pay $40 billion in hidden taxes so they can get 10.4% MP guaranteed pension returns and union pension bailouts.

        Ottawa is all about deception to get more of peoples wealth to fund bailouts, buddy deals, inflated contracts, union pension bailouts and raises, equalization waste for nothing…..have to fund statism as it isn’t free, and they just raised the cumulative inflation tax on us all.

        • The tax brackets are indexed.

          Your point would be valid if 100% of Canadian purchases were made in USD. They are not. Exchange rate fluctuations impact CPI over time.

          • Yep, 6% and now 9.9% inflation and a 1% increase.

            But the indexing for disabled, pensioners, savings, incomes isn’t high enough to compensate for the REAL inflation.

            Reality is currency devaluation is inflation. If I make a ton of product, am I going to sell it to you for 91 cents or sell it to USA or other countries for a whole dollar?

            If I make a product in US for $10, say peanuts. When you buy the next load I want $10, so you need $10.90 to buy it.

            Everyone eventually loses in devalued money. Take Zimbabwe 100 trillion note and a loaf of bread is worth more:

            http://en.wikipedia.org/wiki/File:Zimbabwe_$100_trillion_2009_Obverse.jpg

            Not many jobs in Zimbabwe as one of those notes isn’t worth showing up to work. Issues in 2008/9 its now worthless. But hey, they printed lots of toilet paper money as plastic doesn’t work as well. Did you know BoC creates more dollars electronically than we consume in sheets of toilet paper?

          • China has done pretty well with their devaluation.

        • Tell her to buy local. Then you do not need to worry about devaluation.
          Besides devaluation will hopefully do something to address our Balance of trade deficit which hopefully lead to more employment and better finances.

      • Poor seniors DO receive inflation indexed GIS and each time the CPP or OAS goes up, the GIS comes down or one gets put in a different tax bracket and the entire pension goes down. My mother’s pension recently went down a solid $20 a month after one of those “raises”. She just makes base pension but the taxes on her place went up a hundred a year, her Blue Cross and home insurance all went up. Needless to say, it sounds good but doesn’t work as advertised.

        • GIS is only intended to supplement seniors with very low incomes, hence the clawback. OAS isn’t clawed back at all until over $60k income per person.

          • “Very low incomes” amount to anything under the poverty level. You are right about the OAS but claw back for GIS begins at about $15,900 or thereabouts. She gets about $1,300 a month but when the OAS goes up, her GIS goes down. Quite often it amounts to less per paycheck. I don’t know how that works but she certainly notices it. Her income has remained more or less at the same level overall for the last five years, teetering up then down.

    • Yep, and every premier and PM/party leader in this country wants the people to have less so the government can have inflation debt tax.

      Does it mater if a household budget goes bankrupt from 100% inflation on food or higher interest rates?

      Some amount of inflation and/or higher rates are coming. People in debt better get their cash flows in order as 9.9% inflation to their budgests are coming. Even homes, toilets, appliances, copper all 9.9% more expensive in terms of a 9 cent CAD drip. The equation is 1.00 / .91 = 9.9% more CAD costs to buy the same USD/world priced item. As materials and items will eventually cost 9.9% more, might not want to push the wages as if your customers consume less, you are potentially unemployed.

      Ottawa and provinces just shot Canadians in back, devalued incomes, devalued pensions, devalued savings, devalued investments, we will fail as people with less money, less vlaue money will consume less goods and sevices and drive unemployment. A lower standrd of living is inevitable.

      As wages are too high, and the net after tax value including hidden taxes and protectionism will put Canada in the poor house. It costs too much to be a Canadian will even affect the quality of immigration. Doctors and skilled will hold out for USA and we get the left overs.

  3. More propaganda.

    While it is correct to say people do get paid far more than is supportable and competitive, its also true to say after all the taxes in income/employment/property/utility and a glut of real and hidden inflationary tax costs, Canada isn’t a cheap place to live.

    Screwing seniors pensions with 9% devaluation in 2013 is a 9.9% inflation that is coming from debt/currency fraud. BoC/Ottawa and debt/bloat provinces are devaluing us to preserve governemtn bloat and waste.

    Its why governemtn has been pumping the offshore account propaganda. Those that moved $100,000 CAD in January 2013 now have $109,900 and thats without risk, dividends gains and taxes. And if invested, could be in terms of CAD a 20% gain. But I have 55% of my cash investments offshore as I could see this corruption coming.

    But hey, government loves gullible public that doesn’t understand REAL economics. The new reality for Canada *(and US/UK) is that government debt and waste -> devalues us all.

    Reality is, Canada’s economy is faling. Union and governemtn idiots still flalsy think devalued money is going to save jobs. Reality is, can your employer pass on 9.9% increased costs in material to keep you employed, and most likely it will not keep everyone employed as people eating inflation, devalued savings and pensions are going to spend less not more.

    Its why Heinz and Bombardier are laying people off, their input costs went up 9.9% and their customers would have none of that.

    Enjoy EI, it has 9.9% less value than a year ago. But this is economics reality and no amount of statism (big fat wasteful government) propaganda is going to change reality.

    Clearly, big fate wasteful government is more important than the people who support it. It is destined to fail.

  4. Macleans, really want to show Canadians what is going on? Add in a line on the chart with governmental average wages. It should shock people towards reality. We have become economic slaves of state.

  5. How nice. Your sympathy for the Canadian people is touching. Your apologizing for the Bank of Canada is deceiving. The inflation rate is based on lies and manipulation. It is at least 10% not the 2 percent claimed by the enablers of corruption. The people of Canada are paying the price of allowing central bankers and crony capitalists to run the show.

  6. How about leading by example. I’ll leap if you go first.

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