The Spectre of Deflation

Seasonally-adjusted consumer prices fell by 0.5% between September and October. While less dramatic than the 1.0% drop in the US, the sudden drop in Canadian prices also raises the possibility of deflation.

The annual inflation rate declined from 3.4% in September to 2.6% in October, well below the US rate of 3.7% in October. This pace could put Canada on the cusp of deflation, even in annual terms, within three months. Anecdotal evidence suggests that prices have continued to decline in November.

Deflation is of grave concern because consumers would rationally delay purchases on the expectation of falling prices. This reduction in consumer spending would further damage the economy, pushing prices even lower and further delaying purchases.

Of course, in an immediate sense, lower consumer prices benefit consumers. From October 2007 to October 2008, the increase in average hourly wages exceeded the increase in consumer prices by 1.7%. While hardly breathtaking, this improvement in purchasing power is slightly better than that experienced in several recent months.

Nevertheless, inflation completely eliminated wage gains in Nova Scotia. Real wages rose by a meagre 0.7% in Ontario.

Today’s news confirms that the Bank of Canada should have cut interest rates more deeply last time. Certainly, it should cut interest rates at its next scheduled announcement on December 9, if not before.

The main rationale for lower interest rates is to stimulate the worsening economy. However, even the more narrowly defined goal of keeping inflation around +2% and out of negative territory warrants lower interest rates. Of course, as noted in previous commentaries, monetary policy will not be enough and fiscal stimulus is urgently required.

Wages and Inflation, October 2007 – October 2008

 

Wages

Inflation

Real Wages

Canada

4.3%

2.6%

1.7%

NL

6.4%

3.5%

2.9%

PEI

8.2%

3.9%

4.3%

NS

3.4%

3.4%

0.0%

NB

4.6%

1.8%

2.8%

QC

3.8%

2.3%

1.5%

ON

3.2%

2.5%

0.7%

MB

4.2%

3.0%

1.2%

SK

6.3%

3.5%

2.8%

AB

6.2%

2.4%

3.8%

BC

6.5%

2.5%

4.0%

UPDATE (Nov. 24): CanWest coverage

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