The Canadian economy has been slowly recovering from the recession. So have some other economies. I want to be able to explain what is going on.
I understand why economies go into recession. At least I think I do. AD falls, many prices and/or wages are sticky, so real output falls. Done. But what about recovery from recessions?
In ECON 1000 I tell my students that prices and wages eventually fall (relative to trend), so the economy moves slowly down along the AD curve, and recovers by itself. Monetary and/or fiscal policy can and should be used to speed things up, by shifting the AD curve right, but aren't needed except to speed things up. But if they did shift the AD curve right to speed things up, prices and wages wouldn't need to fall, and the economy could recover immediately.
But, given current monetary and fiscal policy, I have no reason to believe the AD curve slopes down. And falling prices (relative to trend) can create expectations of falling prices, which can reduce aggregate demand. And there is the empirical problem. In Canada, prices have only recently begun falling, relative to trend, despite the slow recovery. (Except for that brief period when the recession began.) So I am not satisfied with my ECON 1000 explanation of recovery.
I am tempted to give a hybrid AD/PSST explanation.
The fall in AD, given sticky prices and/or wages, causes the recession. The recession breaks (Arnold Kling's) Patterns of Sustainable Specialisation and Trade. It takes longer to rebuild PSSTs than it does to break them. If, during the recovery, AD shifts right faster than PSSTs can be rebuilt, the result is that prices rise relative to trend. If AD shifts right more slowly than PSSTs can be rebuilt, prices fall relative to trend.
The speed at which PSSTs can be rebuilt creates a recovery-speed limit. This may be greater than the normal speed limit of an economy that is not in a recession nor recovering from a recession, but it is still finite.
The fact that inflation is currently below target suggests that AD is not being shifted right fast enough at the moment. We are currently below the recovery-speed limit, but we were at or above that recovery-speed limit earlier in the recovery.
For an open economy, like Canada, a lot of our PSSTs are with foreigners. Americans especially. That's why Canadian recovery depends on US recovery, even though we have our own monetary policy so we can make our own AD curve shift independently of the US AD curve, if we want to. The Canadian recovery has been slow because the US recovery has been even slower. We can't rebuild some of our PSSTs until the Americans rebuild some of theirs. We are waiting for the Americans to join in our cross-border PSSTs.
Maybe if AD had increased immediately after it fell, the same old PSSTs that were broken could have been put back together again very quickly. But if there's any delay, and people and firms move on to something else, or disappear, the new PSSTs won't be the same as the old ones that were broken. And it takes longer to build new PSSTs than to repair the old PSSTs.
My alternative explanation is that, some some unknown reason, it just took a very long time for the recession to cause prices to fall relative to trend, except for a brief blip down at the beginning of the recession. Inflation is very sticky, and adjusts only with a long lag. Maybe inflation targeting made inflation stickier.
Just for background, here are the data on employment, unemployment rate, and CPI level, all from Statistics Canada's latest releases:
CPI level, just above.