Although demand forces contributed to this rise, supply-side factors drove the largest share of the increase. For example, the surge in inflation of goods prices largely reflected shipping bottlenecks, shortages of key inputs and higher energy prices. And for services, it partly reflected labour shortages and capacity constraints that added supply pressures.

Supply-side challenges later eased, helping bring inflation back toward the midpoint of the Bank of Canada’s 1%–3% control range.

Over the coming years, supply shocks could continue to be more frequent and larger than before the pandemic because of climate-related disruptions, geopolitical tensions and the reshaping of global trade networks. These forces could put renewed pressure on energy costs and supply chains, making supply-side factors a more frequent source of inflationary pressures.

Large supply shocks increase the likelihood of high inflation and a recession

To better understand how more frequent and larger supply shocks could affect the economy, we turn to the Bank’s Terms-of-Trade Economic Model.

Starting with a stable economy in the model, we generate thousands of possible economic paths by repeatedly exposing the model to supply and demand shocks consistent with historical patterns. The model then traces how inflation, output and interest rates evolve over time.

We run three sets of simulations, each representing a different supply-shock environment. The supply shocks differ only in size and frequency—the persistence is held constant. Each simulation is calibrated using supply shocks estimated from different periods of Canadian economic history:

• the normal case uses supply shocks from 1995 to 2019
• the moderate case uses supply shocks from 2022 to mid-2025
• the large case uses supply shocks from 2020 to mid-2025, which include the exceptional disruptions during the pandemic

The results show that moderate supply shocks make episodes of high inflation more frequent than in the normal case, but they do not significantly lengthen those episodes or greatly increase the risk of a recession (Table 1).

The picture changes when supply shocks are large. High inflation sticks around for about two quarters longer than it does in the normal case. The risk of a recession also rises, but the length of a recession changes little because our simulations increase the size of a shock and not its persistence.