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Bank of Canada betting high job vacancies will cushion rise in unemployment

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As the Bank of Canada squeezes the economy with higher interest rates, central-bank economists are betting that unemployment won’t spike as much as in previous downturns because of the elevated level of job vacancies across the country.

There were nearly a million unfilled positions in August, according to the latest Statistics Canada data. With the economy expected to stall in the coming quarters, central bankers anticipate that companies will remove job postings without also laying off a large number of workers.

This is key to the bank’s “soft-landing” narrative: the notion that inflation can be brought under control without causing a major recession or too much pain to Canadian workers. Critics, however, argue that the bank is being overly optimistic about job vacancies acting as a cushion for falling labor demand.

A Bank of Canada research paper, published last week, estimates that the unemployment rate would “most likely” rise to around 6.7 per cent if demand for workers drops back to pre-pandemic levels. That’s up from a near-record low unemployment rate of 5.2 per cent last month.

This would amount to a “material” increase in unemployment, Bank of Canada economist Alexander Lam wrote in the paper, although it would be “far below what has historically been observed during recessions.”

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mr. Lam’s paper is not a formal unemployment forecast. It’s an analysis of the relationship between job vacancies and unemployment, known as the Beveridge Curve, which presents several hypothetical scenarios rather than a forecast based on actual economic projections.

Nevertheless, the paper’s “base-case” scenario – a 1.5-percentage-point increase in unemployment – ​​appears to be the central bank’s in-house outlook for the labor market. Bank of Canada Governor Tiff Macklem cited the research in a speech on the Canadian labor market earlier this month.

“Generally speaking, when job vacancies are high, as they are now, a decline in vacancies does not lead to as big an increase in unemployment as it does when job vacancies are low to begin with,” Mr. Macklem told a Toronto audience.

“So what does that mean for Canadian workers? Well, it’s clear that the adjustment is not painless. Lower vacancies mean it could take longer to find a job, and some businesses will find that with less demand for their products, they don’t have enough work for all their workers,” he said.

The Bank of Canada is not a passive participant in this process. mr. Macklem and his team are actively trying to weaken the labor market by raising interest rates and curbing demand for goods and services. They argue that an overly tight job market is fueling inflation, as companies raise wages to compete for scarce workers, then raise prices to cover their higher labor costs.

Average hourly wages were up 5.6 per cent in October compared with the previous year – a rapid rise by historical standards although still below the rate of inflation. The Canadian economy also added 108,000 jobs that month, exceeding expectations and illustrating the resilience of the job market in the face of rising interest rates.

The central bank’s analysis of the Beveridge Curve suggests a goldilocks scenario: business demand for workers drops enough to slow the pace of wage growth and ease inflationary pressures, but not enough to cause widespread job losses. Companies that have struggled to find employees may be reluctant to lay people off.

This thinking has been criticized on several fronts. When the US Federal Reserve made a similar argument earlier this year, former US treasury secretary Larry Summers and former International Monetary Fund chief economist Olivier Blanchard said the analysis was based on theoretical errors and a disregard for history. Every decline in job-vacancy rates since the 1950s has been accompanied by a significant rise in unemployment, they argued.

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In Canada, unions have started warning that the central bank is underestimating how much harm it will do to Canadian workers if it continues increasing interest rates. The bank has raised its benchmark rate six times this year, to 3.75 per cent from 0.25 per cent, and it is expected to announce another rate hike in December.

“The idea that somehow people won’t be laid off in a recession because employers have so many unfilled vacancies right now is an absolute rose-colored fantasy,” Jim Stanford, director of the Center for Future Work, a progressive think tank, said in an interview.

“If a business sells less output because of a recession, they don’t just take down vacancies – the vacancies aren’t producing anything – they lay off workers,” he said.

The Bank of Canada paper does present three other potential scenarios alongside its base case. These range from a more mild 1.1-percentage-point rise in unemployment to a devastating 4.5-percentage-point increase, which would see hundreds of thousands of Canadians losing their jobs.

The scenarios vary based on assumptions about the job turnover rate and matching efficiency: how good the economy is at pairing businesses looking for workers with workers looking for jobs. Matching efficiency worsened during the pandemic, although it has since normalized, Mr. Lam wrote in the paper.

Brendon Bernard, senior economist with Indeed Canada, a job-posting website, said that the paper’s base-case scenario is plausible, assuming that the economy stalls rather than crashes. The Bank of Canada is currently projecting three quarters of near zero growth, but not a significant economic contraction.

“If a serious recession isn’t their base case… it is generally reasonable that [job] separations tick up a bit, but we don’t see a wave of layoffs that really shake the labor market,” Mr. Bernard said in an interview.

Job vacancies have begun to trend down, falling from a high of 1.03 million in May to around 960,000 in August, according to Statscan. But shortages of workers remain a major issue across industries.

“Canadian job postings have indeed peaked in early May at really elevated levels. They eased pretty steadily throughout the summer, but since the start of fall or so, things have actually stabilized,” Mr. Bernard received.

A notable exception is the technology sector, he said, where job postings have fallen considerably in recent months.

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