The Canadian economy recently posted two quarters of decline, sparking a debate among economists about whether Canada is in a recession. Then, just as quickly, many decided that the question was beside the point: Canada’s real problem is years-long stagnation.
In addition to the recent decline in GDP being modest and brief, they argued that population growth misleadingly inflated earlier economic growth numbers and the current population decline is having the opposite effect. Underneath it all, they say, is a story of long-term stagnation. As economist Frances Donald put it, “we’re talking about the patient having a headache when the patient has a broken arm”.
That view is only half right.
Yes, Canada has struggled for years and that’s a serious problem. Business investment has been meek, productivity has lagged peer countries, and per capita GDP has barely budged. These are important issues that require immediate attention. But it would be misleading to suggest that our current economic weakness is only a reflection of this longer-term trend. A better way to put it is that Canada was already down and is now taking further hits.
In other words, stagnation aside, the current economic environment comes with its own set of unique challenges. For businesses tied to the U.S., nearly every week of the past year has come with a new tariff, threat, or major political decision from our closest trading partner. Certainty, the lifeblood of major investment decisions that drive the economy, has been in short supply.
Our best measure of this, the Economic Policy Uncertainty Index, has sat at historic highs for more than a year, averaging 993 compared with the historical norm of just 157. And while it’s come down from the extraordinary levels around President Trump’s “Liberation Day” last spring, its current 3-month average is still higher than those early COVID months when some businesses didn’t even know if they could operate. As the CUSMA review inches closer, whether the long-standing trade agreement will survive or be torn to shreds is unclear on any given day.
Canadians are feeling it, too. Though the labour market has generally held up, jobs have been lost in trade-exposed sectors, and youth unemployment is at its highest level outside of a recession in decades. At the same time, high gas prices brought about by the war in the Middle East are taking a bite out of household incomes. Even in Alberta, which has the strongest outlook and has benefits from those high prices, the majority of residents believe the economy is worsening and risks are high given U.S. exposure.
As of now, Canada is not in a recession — defined as a pronounced, persistent, and pervasive downturn in economic activity. But the risk that today’s challenges, piled on top of longstanding weakness, could tip Canada into one shouldn’t be taken lightly. And if it does, the tools to ease the pain are limited.
The federal government has little fiscal room to respond: the deficit has nearly doubled to $72 billion this year, and the Parliamentary Budget Office (PBO) puts the odds of government meeting its own fiscal target over the next few years at less than 1%. The Bank of Canada is constrained too: any boost from monetary policy risks reigniting inflation that hasn’t cooled.
Even recessions that are met with strong policy support leave lasting marks. Research finds that most economic downturns leave scars, with economies still running below potential several years after a recession ends.The consequences of a recession hitting Canadians while they’re already down could be grave, from rising long-term unemployment to the erosion of skills and incomes.
Technicalities aside, Canada is not yet in a real recession, but for an already-compromised patient, today’s challenges are serious blows. If the current dip in economic activity does turn into a prolonged downturn, it wouldn’t just be a continuation of the slow growth we’ve gotten used to, it would set us even further back from that problematic starting point.
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