Lower Inflation Frees Central Bankâ€™s Hand
The Consumer Price Index decline in March confirms that deflation remains a greater risk than rising inflation. The annual inflation rate fell to 1.2% nationally and turned negative in one province, Prince Edward Island. The recent revelation of the first annual decline in American consumer prices in half a century underscores concerns about deflation.
While falling prices benefit consumers with a given income, they could deprive many workers of income. Noting that prices are falling, consumers may delay purchases in anticipation of even lower prices. The reduced level of spending would prompt businesses to cut back production and lay off workers, further reducing consumer spending and placing additional downward pressure on prices.
Even if a deflationary spiral remains unlikely, the risk of rapidly rising inflation is even more remote. Therefore, monetary policy can and should focus on providing as much economic stimulus as possible without fear of inflation in the near term. In that vein, I have been calling since January for the Bank of Canada to set its target interest rate at zero, as the US Federal Reserve has done.
While the Bank of Canada has cut interest rates, latent fear of inflation seems to have prevented it from cutting as far or as fast as possible. Todayâ€™s inflation numbers should encourage the Bank of Canada to announce a lower target rate on Tuesday and move ahead with quantitative easing.
Even the C. D. Howe Instituteâ€™s usually conservative Monetary Policy Council called yesterday for a 0.25% target rate. Since the Bank of Canadaâ€™s target range is typically +/-0.25%, a 0.25% target rate would set the bottom of this range at 0%. (To symbolically avoid this outcome, the C. D. Howe group is also proposing that the central bank narrow its official target range.)
Although rising inflation is not a serious threat in any province, todayâ€™s Consumer Price Index indicated significant regional variation. For example, Ontario tied Saskatchewan at 1.8% for the countryâ€™s highest inflation rate in March. The Labour Force Survey indicates that Ontario tied Alberta at 3.6% for the lowest average wage increase in March. As a result, even todayâ€™s modest inflation eliminates half of the annual improvement in Ontarioâ€™s average hourly wage. With many Ontario workers receiving fewer hours of paid employment, it seems likely that total purchasing power is declining.