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Inflation as measured by the CPI accelerated from 2.8% in June to 3.3% in July and 4% in August. The upturn was widely expected by analysts, including those at the Bank of Canada, because of base year effects. Basically, the drop in gasoline prices last year is being replaced in the index by this summer's high gasoline prices. However, more than energy prices are pushing up inflation. Measures of core inflation remained stubbornly near 4% even as lowered gasoline prices pulled down headline inflation. The cost of services rose 4.3%, led by a surge in shelter, notably a 6.5% increase for renters as Canada's housing shortage worsened.

It is remarkable that the Bank of Canada and the Federal Reserve board in their latest projections do not see inflation returning to its target level until 2025. This admission of failing to achieve their inflation target for another two years was not accompanied by a change of policy. However, the growing realization that inflation will be higher for longer is pushing up longer-term interest rates anyway.

It was predictable that the deceleration of inflation during the first half of 2023 would not last. Most of the easing of headline inflation was due to the resolution of some supply issues, notably in the energy sector after Russia's invasion of Ukraine. The underlying trend of demand has barely slowed outside of new home construction, suggesting that interest rates still are not high enough to substantially lower demand.

This is especially true in an environment in which governments continue to run deficits, notably in the U.S., where the federal deficit of 8% of GDP in the year ending in July is stimulus that is usually associated with wars and not an economy operating at full employment. Meanwhile, households still have substantial savings accumulated from excessive government transfers during 2020 and 2021. One result is that, after an initial downturn in the spring in response to higher interest rates, house sales began to heat up again over the summer after the Bank of Canada prematurely indicated that it would pause in further interest rate hikes.

The ongoing imbalance between aggregate demand and supply is reflected in continued low levels of unemployment. Low unemployment puts upward pressure on wages, with increases in average hourly earnings remaining close to 5%. The upward pressure on wages is continuing to build, with several high-profile strikes across North America. While an understandable reaction to higher inflation, continued high wage inflation risks making it difficult to return to 2% inflation. Jerome Powell, the federal chair, recently said that wage increases of 3% to 3.5% were consistent with its 2% inflation target. The implication is that sustaining current wage growth of well over 4% is not.

It is difficult to analyze the labour market after the pandemic. Many workers left their jobs during the pandemic, especially workers in such low-wage service jobs as accommodation and food and retailing. There was speculation that these workers would move to higher-paying jobs or upgrade their skills by returning to school. In the short run, we did see severe labour shortages in these industries. However, there has been no improvement in aggregate labour productivity. In fact, labour productivity has worsened significantly since early 2021, with eight declines in the last quarters. The only increase was 0.1%, for a total drop of nearly 6%. The slump in productivity cannot be blamed on the pandemic, as labour productivity fared markedly better in the U.S. than in Canada.

Comparing Canada and the U.S. also shows another glaring missed opportunity. Oil and gas production in the U.S. has risen 40% since 2017, fuelled by the technological innovation of fracking and higher prices, especially in Asia and then Europe after Russia's invasion of Ukraine. Faced with these same opportunities, oil and gas output in Canada eked out less than a 10% gain, hampered by a lack of pipeline capacity and regulatory uncertainty surrounding oil and gas extraction.

It is striking that the same circumstances produced such different results in Canada and the U.S. The surge in the U.S. shows there clearly was a business case to increase production. Nor did higher oil and gas production prevent the U.S. from substantial reductions in greenhouse gas emissions during this period, down 14% from its 2005 baseline versus only a 5% drop in Canada. Canada's attempt to straddle the middle of the road between the opposing lanes of faster economic growth and lower emissions led to it being run over in both directions: We achieved little economic income growth without lowering emissions significantly.

Underachieving has become habitual in Canada over the past decade as we have ignored or even been outright contemptuous of entrepreneurship and innovation.

Thank you.

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