Government Pressure to Cut Wages Will Increase the Risk of Deflation

A group of economists from across Canada are concerned about the federal government’s response to the auto crisis that blames the CAW for a crisis it didn’t create.  They’ve signed the following open letter outlining their concern that government pressure to cut wages will increase the risk of deflation and calling for new and focused action from the government.

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Government Pressure to Cut Wages Will Increase the Risk of Deflation

It is now abundantly clear that Canada and the world is facing its worst economic crisis since the Great Depression.  However, a sense of premature Hoover-type optimism seems to have settled in to Ottawa’s thinking, breeding a dangerous complacency that the government has done all that is required to combat the recession.  The federal government appears to be hiding behind the proposition that with strong banks and strong fundamentals, the Canadian economy will automatically recover as US demand picks up.

The Bank of Canada has lowered its interest rate to a near-zero level and has provided banks with billions of dollars of liquid assets to counter the recession and potential deflationary expectations.  It is concerned that deflation, or falling prices, will become generalized throughout the economy.  And once the cycle becomes entrenched, as it did during the 1930s, it will be extremely difficult to reverse.

The federal government’s fiscal stimulus package is beginning to inject demand into the economy to counteract the contraction of private sector demand, although many economists argue that a federal deficit of about 2% of GDP is too little given the powerful headwinds the nation faces.  Unemployment insurance, though greatly weakened by previous governments (most recently the self-financing rule imposed by the 2008 Budget), will also help somewhat cushion the fall in demand.

Government is the player responsible for the overall management of the economy.  At a time like this it is the only player that is capable of overriding destructive contractionary impulses of private businesses and households.

The federal government is undermining the effectiveness of its own stimulus efforts by freezing wages of its own employees and by forcing massive auto sector wage concessions (which incidentally will not solve the auto crisis) as a condition of providing financial support to the industry.

It also sends a contradictory signal to business that somehow this ‘belt-tightening’ is good for the economy as a whole.  On the contrary, it will only make matters worse.

While it may be rational for an individual firm trying to stay afloat to lay off workers, reduce working hours, and/or push for wage reductions, if this becomes an economy-wide phenomenon the resulting downward wage-price-purchasing power spiral, if unchecked, will deepen and prolong the recession.

This is what happened during the Great Depression.  The deflationary cycle became entrenched.  Massive price declines in both the US and Canada were matched by a similar drop in average wages.  Keynes argued for nominal wage anchors to stem the downward spiral.

One of the things Roosevelt did when he came to power in 1933 was to support the Wagner Act, which strengthened unions, setting a floor on wages and initiating a process of rising wages, prices and production.

The current economic crisis was caused by the meltdown of the bloated US financial sector, not by ‘exorbitant’ auto or public service sector wages.  Forced wage rollbacks will cascade through the economy reducing purchasing power and demand, offsetting the very thing the government is trying to reverse with its stimulus policies.  The collapse of the auto sector (just like the collapse of the financial sector) will most certainly turn the current recession into a deep depression.

Rather than scapegoating the CAW for a crisis it did not cause, the federal government should focus its efforts on combating the pressures of wage-driven deflation, maintaining income and employment, and using public dollars to buy transformation of the auto industry away from gas-guzzlers to the low emission vehicles of the future.  Industrial policies like this have been an important part of the development of the auto industry and are needed once again.


Armine Yalnizyan, Senior Economist, Canadian Centre for Policy Alternatives

Arthur Donner PhD, Economic Consultant

Bruce Campbell, Executive Director, Canadian Centre for Policy Alternatives.

Charlotte Yates, Labour Studies and Political Science, McMaster University

Diane-Gabrielle Tremblay, Télé-université de l’Université du Québec à Montreal

Frédéric Hanin, Département des relations industrielles, Université Laval

Harold Chorney, Political Economy, Concordia University

Jean-Noël Grenier, Département des relations industrielles, Faculté des sciences sociales, Université Laval

Gordon Laxer, Political Economist and Director of the Parkland Institute at the University of Alberta

Louis Gill, Department of Economics, Université du Québec à Montréal

Louis-Philippe Rochon, Department of Economics, Laurentian University

Marc Lavoie, Department of Economics, University of Ottawa

Margie Mendell, School of Community and Public Affairs, Concordia University

Mario Seccarreccia, Department of Economics, University of Ottawa

Marjorie Griffin Cohen, Department of Political Science/Women’s Studies, Simon Fraser University

Mel Watkins, Department of Economics (emeritus), University of Toronto

Myron J. Frankman, Department of Economics, McGill University

Pierre-Antoine Harvey, Économiste, Chercheur à l’Institut de recherche et d’informations socio-économiques (IRIS)

Ricardo Grinspun, Department of Economics, York University.

Robert Chernomas, Department of Economics, University of Manitoba

Ruth Rose, Sciences économiques, Université du Québec à Montréal

Sylvie Morel, Département des relations industrielles, Université Laval

Trevor Harrison, Political Economist and Political Sociology, University of Lethbridge