Dash to Deflation
Todayâ€™s Consumer Price Index suggests that Canada is lunging toward deflation. The annual inflation rate plummeted to just 1.2% in December, 2.2% lower than only three months ago. If this pace continues, the national inflation rate will turn negative in the next few months. Two provinces, Nova Scotia and New Brunswick, already recorded negative inflation rates in December.
Of course, a large drop in gasoline prices pulling down the Consumer Price Index does not necessarily constitute deflation. The key question is whether there will be a sustained, generalized decline in prices. Since fuel is an input to so many other goods and services, it is possible that Decemberâ€™s huge drop in gasoline prices (the largest ever recorded in Canada) will put downward pressure on other prices in the coming months. In other words, the threat of deflation is real.
Another consideration is that recessions almost always reduce prices. Between 1982 and 1983, the inflation rate fell by 5.1%. Between 1991 and 1992, it fell by 4.2%.
The release of figures for December 2008 reveals an inflation rate of 2.3% for the whole year. If the experience of previous recessions were applied to this starting point, Canada would experience deflation ranging from -1.9% to -2.8% in 2009.
While deflation would be a boon to those consumers who retain their incomes, it could deprive many Canadians of their jobs. 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 and perpetuating the deflationary spiral.
Todayâ€™s figures confirm that the Bank of Canada should have cut interest rates further than it did on Tuesday. They also indicate that the federal budget should inject more public spending into the economy as opposed to providing tax breaks that might well be saved (rather than spent) in anticipation of even lower prices in the future.
UPDATE (Jan. 24): Quoted by CanWest