Recession or a coming financial crisis? Economists say the difference is vast
CBC
Interest rates are creeping higher, and the word "recession" is on everyone's lips.
But so far, only a few financial commentators are warning of something much worse that could abruptly change the rules of the game: The threat of a financial crisis.
On Wednesday, the Bank of Canada is preparing to announce what's expected to be another large hike in interest rates, continuing its battle against stubborn inflation.
The bank's governor, Tiff Macklem, has repeatedly and confidently said that neither the risk of a recession nor falling house prices will stop him from getting inflation down to its target range, two per cent.
In a business that depends on confidence, central bankers must be master poker players. They can't be seen to be sweating when they have a tricky hand.
Keeping inflation down is Macklem's clearly stated priority, but if history is a guide, he and his U.S. counterpart, the Federal Reserve's Jerome Powell, will likely be putting plans in place for an even more important duty — preventing their own and the world's financial systems from falling into confusion.
Doubters who need historical evidence can gaze back three weeks, when the Bank of England dropped everything to save the U.K. bond market and pension system.
For the general reader, the details are arcane, but after disruption of the markets by the British government's tax and borrowing plan, a kind of private sector insurance scheme by pension plans faced liquidation, "driving a potentially self-reinforcing spiral and threatening severe disruption of core funding markets and consequent widespread financial instability," according to a letter from the Bank of England deputy governor Jon Cunliffe.
After the fact, everyone played down the danger. But in the immediate aftermath, as the pound was plunging, one experienced London bond trader described the crisis as a potential "Lehman moment," harking back to that instant in September 2008 when the U.S. subprime mortgage crisis turned into a full-fledged banking crisis as Lehman Brothers declared bankruptcy.
The authors of an article for the financial services company Morningstar titled "Why Are Fears of a New Financial Crisis Growing"? were careful to play down the risks. But the sudden and unexpected disruption in British markets came as a useful reminder that central bankers must be prepared for trouble.
"Financial crisis is a new focus," John Canavan, lead analyst at Oxford Economics, told Morningstar. "It does appear that growing financial stability risks raises the possibility that the Fed may need to react to financial stability concerns before its goals are reached on inflation."
Economists who spoke to CBC News said that before financial crises happen it is hard to know for sure where and how they will appear. But central banks say they know one when they see one.
The peril of failing to respond to an unfolding financial crisis harks back to the 1930s, when a sudden market crash in 1929 led to a cascading series of problems. Investment loans were called in and banks ran out of money. Businesses big and small collapsed. One-quarter of employees were thrown out of work, and the Great Depression was born.
"In a financial crisis, some sectors of the financial system are failing," said Angela Redish, an economic historian at Vancouver's University of British Columbia. "Financial crises almost always lead to recessions, but not all recessions lead to financial crises."