Inflation, Wages and Interest Rates

This morning, Statistics Canada released the Consumer Price Index (CPI) for June. Inflation driven by commodity prices justifies higher wages, but should not prompt the Bank of Canada to hike interest rates.

Inflation and Wages

Rising consumer prices nullified most of the wage gains that Canadian workers made during the last year. From June 2007 through June 2008, consumer prices and average hourly wages rose by 3.1% and 4.4% respectively. In real terms, workers are being paid only 1.3% more per hour than last year.

Workers in Nova Scotia are being paid significantly less per hour than a year ago. In that province, real wages dropped by 2.6% as above-average inflation (4.2%) overtook meagre wage increases (1.6%). Real wages stagnated in Quebec because average inflation (3.1%) nearly equalled below-average wage increases (3.3%).

Conversely, Newfoundland and Saskatchewan led the country with real-wage gains of 5.4% and 4.4% respectively. Wage improvements are long overdue in these provinces, where recent economic booms raised corporate profits more than employment incomes.


Wages and Inflation, June 2007 – June 2008




 Real Wages














































Why CPI Jumped

As emphasized by Statistics Canada, annual inflation was driven by the rising cost of gasoline (up 27%), bakery products (up 12%), and mortgage interest (up 9%). Canadian monetary policy has almost no effect on global fuel and food prices. These prices do not provide a rationale for maintaining or increasing Canadian interest rates.

However, lower interest rates would help ease mortgage-interest costs. The federal government can and should use other regulatory tools, such as mortgage-insurance rules, to reign-in mortgage lending. Two weeks ago, Finance Canada reduced the maximum amortization period from 40 to 35 years and required at least a 5% downpayment for federal mortgage insurance. Clearly, there is room to further reduce amortization and increase downpayments.

Core Inflation and Monetary Policy

Core CPI, which excludes the CPI’s most volatile components, rose at an annual rate of 1.5%. In other words, the Bank of Canada’s “operational guide” for monetary policy remained well below the 2% target in June. This revelation raises further questions about the Bank’s decision not to cut interest rates last week in the face of an overvalued currency and slowing economy.

UPDATE (July 24): This post is quoted today in The Toronto Star, Le Devoir, and several CanWest papers.

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