Canada’s inflation has been quite low in the last couple of years, but this luck could run out with the figures for April showing a rise. Higher inflation could have dire consequences for the economy.
Canada has been lucky with inflation for two reasons, firstly the Canadian dollar has been appreciating against other currencies and property prices have diverted money away from the “real” economy. The rise of the Canadian dollar means that import prices are falling – which gets reflected in shop prices. The second thing that has been keeping retail prices down is the mad rise in property prices which has been tying up a lot of the spare money in the system.
It is important to remember exactly what inflation is and what the effects of inflation are. Inflation is an increase in the supply of money. Inflation is not a rise in prices. Rising prices are merely the most obvious symptom of inflation. Rising prices could be caused by a reallocation of demand or resources within the economy, or else it could be due to inflation when prices in general are going up across an economy.
Inflation is the increase in the amount of money in the system. This may not be met with rising prices straight away, although it almost always is met by rising prices which can take some time. The prices that are rising are often not well covered in the statistics.
An example of prices that are rarely covered in “inflation” statistics is the price of assets. If a house doubles in value then this means that a person will have to take twice as long to save their deposit and have to pay twice as much in repayments. This is a very real increase in the cost of living, but it is rarely covered in the statistics. Similarly if share prices go up this means that the income that is generated per dollar goes down, so to get a certain amount of dividend income in retirement years it is now necessary to buy more shares. However share prices are never included in inflation statistics.
Inflation can have some really disruptive effects, particularly if the economy is simultaneously heading for a fall. This combination of stagnation and inflation is called “stagflation” and can be particularly hard for policy makers to deal with, as measures to combat inflation will increase the number of unemployed and efforts to get people back to work will increase the cost of living across the board.
So what is the outlook for inflation in Canada? Underlying inflation in Canada is rising for consumer goods, and the same has been happening for asset prices. Although a 1.1% underlying rise looks small, this is after stripping out the large increase in fuel costs and ignoring the rise in asset prices.
This will mean at some point or other that the Bank of Canada will have to raise its interest rate. The global turmoil is putting a cap on this, for now. This will not last.
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