Supply Shocks May Prolong Inflation and Boost Recession Risk

The Bank of Canada has released research suggesting that supply shocks could prolong inflation and increase the risk of recession. The study modeled how the economy would perform under supply disruptions similar to those experienced during the pandemic, with core inflation remaining above 3% for an average of 5.5 quarters compared to 3.4 quarters before the pandemic.

The researchers found that supply constraints were responsible for a significant portion of Canada's pandemic-era inflation surge, driven by shipping bottlenecks, input shortages, higher energy prices, and limited production capacity.

Climate-related disruptions, geopolitical tensions, and changing global trade relationships may make such shocks more common in the future, complicating interest-rate decisions. The study noted that with more frequent supply disruptions, there is a greater trade-off between restoring price stability and supporting economic activity.