Deflation Marches On
In November, prices fell for a second consecutive month and annual inflation fell for a third consecutive month. The Consumer Price Index declined from 3.5% in August to 3.4% in September, 2.6% in October, and 2.0% in November.
A few more months of decline could turn this annual rate negative. While steadily falling prices would be a boon to individual consumers, they pose a serious threat to the economy as a whole. If many consumers delay purchases in anticipation of future price reductions, firms will reduce output in response to fewer purchases. The correspondingly lower level of employment would further depress consumer spending, forcing further price reductions.
The Bank of Canada must be vigilant to prevent such a deflationary spiral. The expansionary monetary policy needed to ward off deflation is also needed to stimulate economic activity. The US Federal Reserveâ€™s recent announcement of a 0% target interest rate underscores that the Bank of Canada has significant room to cut from its current target of 1.5%.
The Financial Post has recently printed editorials arguing that stimulative policies will create “massive inflation.” Yesterday, the C. D. Howe Institute issued a communiquÃ© entitled “Defending the Bank of Canadaâ€™s Inflation-Control Mandate.” Some of these commentators may point to todayâ€™s core inflation rate of 2.4% as grounds for restraining stimulus.
But it is important to examine the data more closely. The seasonally-adjusted core index rose only 0.5% from October to November after having been completely flat from September to October. Much of the apparent increase in the annual core inflation rate reflects the fact that the core index was flat or falling during the same months of 2007, which provide the basis of comparison.
The risk of deflation and the need for economic stimulus far outweigh any lingering possibility of inflation.
UPDATE (Dec. 20): The online Globe and Mail quotes Ms. Weir on deflation in “Gas prices drive down inflation.” Notably, the edited print version of this story, “Inflation increase surprises economists,” focuses almost exclusively on core inflation. The fact that overall inflation decreased significantly is not mentioned until the final paragraph.