Canada's job growth is challenging basic economic theory. Are the models wrong?

Canada's economy added a stunning 150,000 jobs last month. It's the second straight month that jobs numbers blew well past expectations. And it's yet one more data point that challenges the narrative that Canada needs to shed jobs to bring inflation under control.

"We're seeing a key test of our theories of how labour market tightness translates to wages and from wages to prices," said Brendon Bernard, chief economist at the job search site Indeed.

Economic theory tells us that unemployment and inflation are inextricably linked. As unemployment falls and more people work, inflation increases. And as unemployment increases, inflation drops.

But that's not what's happening here. Inflation peaked in June at 8.1 per cent. It has decelerated considerably since then. In December, it had fallen to 6.3 per cent and is expected to fall all the way to 5.6 per cent when we get January's numbers later this month.

"Theories are always being tested," said Bernard. "But I think in really unique times like this, that's even more the case. Partially because the pressure is really on. There are major policy implications of how things evolve in the next six months or a year."

The policy implications of this are enormous.

Canadians are already squeezed — pinched between rising prices and increased borrowing costs. The Bank of Canada raised rates by another 25 basis points earlier this year. But it also signaled it was ready to pause rate hikes going forward.

"If economic developments evolve broadly in line with the [bank's] outlook, Governing Council expects to hold the policy rate at its current level while it assesses the impact of the cumulative interest rate increases," wrote the central bank in its last decision.

Canada has now added 326,000 jobs since the beginning of September. That was certainly not in line with the Bank of Canada's outlook.

"For the Bank of Canada, the strong [jobs] report must make them at least a tad nervous about their freshly-minted pause — we said the bar for any move would be very high, but the employment gain is pretty towering indeed," wrote BMO Capital Markets chief economist Douglas Porter in a research note.

But economists like Jim Stanford say continuing to hike rates now is unnecessary and needlessly painful. 

He's been saying for months that inflation was driven by global factors like the price of oil and shipping. He says it's been exacerbated at home by corporations hiking prices more than their input costs.

"We've been barking up the wrong tree on both the cause of inflation and how to fix it," said Stanford, an economist and director at the Centre for Future Work.

WATCH | Canada added 100,000 jobs in December: