Chairman's Desk

We are now firmly in the claws of a bear market. The government must prepare people for hardship

Four days remain until the House of Commons rises, and politicians trot back to their constituencies to hit the infamous summer BBQ circuit. While they will surely be grateful for the break, anxiety about a litany of economic harbingers will surely cloud their summer mood.

We are now firmly in the claws of a bear market. For some time, it’s been clear that we are experiencing severe structural inflation, the worst in four decades. Economists may disagree over whether we are heading for a recession, but all seem to agree that short-term pain will be required if we are to get out of this mess.

The federal government now finds itself in unchartered waters. By the prime minister’s own admission, they are not a government overly concerned with monetary policy. And as Thursday’s announcement of another spending package of $8.9 billion shows, they are short of any ideas that don’t involve throwing more money at crises.

But they have another set of problems.

Canadians both expect economic woes to continue, and for governments — especially the federal government — to do something about it.

The latest round of public opinion research by our firm Navigator revealed that nine in 10 Canadians say they are affected by inflation. What’s more, they are pessimistic about the near term, with eight in 10 expecting inflation to rise over the next year.

Crucially, eight in 10 people believe the federal government can reduce inflation — a tough act to follow with so many remedial structural factors beyond the government’s control.

That said, there are tools available to the feds. The idea that people’s behaviour can influence macroeconomic trends used to be considered pseudo-science, yet recent experience has demonstrated the power of good communication and expectation-setting in policy-making.

The 2008 crisis proved the power of economic irrationality, after millions of mortgages were approved without proof of income. Consequently, “nudge theory” — a concept popularized by economist Richard Thaler — rose to prominence among policymakers and new acolytes of behavioural economics.

Nudge theory proposes that indirect reinforcement can influence the decision-making of groups or individuals. Examples include policies to cut down on smoking or plastic consumption.

Our government has experience successfully nudging people’s behaviour. After all, with only warnings and incentives, they were able to garner almost unanimous compliance with lockdown measures.

The nudge concept works alongside another key principle of behavioural economics: loss aversion. The loss aversion principle states that the pain of losing is psychologically far more powerful than the pleasure of gaining. Now is a crucial moment for the government to convey the dangers of our current economic reality, nudge behaviour where it can and manage expectations around loss.

First, the government must avoid panic and a loss of faith in its ability to steer through the storm. An illustrative example comes from Japan. In 1997, during the Asian financial crisis and an abrupt contraction of the economy, long lines began to appear outside major banks. The financial system teetered on the edge. But instead of proliferating, the lines were short-lived and the crisis was averted, as a deliberate lack of media interest and clear government statements reassured citizens.

This summer, the government will have to accept people’s expectations that inflation will continue to be bad, nudge their behaviour in a way that cools the economy in line with central bank measures, and shift expectations away from government to reverse these overarching trends — all while managing the risk of recession.

The government must prepare people for hardship, so when it comes it isn’t unexpected or as bad as first thought. How they communicate inflation, with a view to affecting people’s behaviour, will be just as important as any policy decision.

It’s a tough tightrope to walk, but as behavioural economist Dan Ariely once asked, “Wouldn’t economics make a lot more sense if it were based on how people actually behave, instead of how they should behave?”

This article first appeared in the Toronto Star on June 19, 2022.

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