Lower Inflation Frees Central Bank’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. Today’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 Institute’s usually conservative Monetary Policy Council called yesterday for a 0.25% target rate. Since the Bank of Canada’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, today’s Consumer Price Index indicated significant regional variation. For example, Ontario tied Saskatchewan at 1.8% for the country’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 today’s modest inflation eliminates half of the annual improvement in Ontario’s average hourly wage. With many Ontario workers receiving fewer hours of paid employment, it seems likely that total purchasing power is declining.


  • I will say this,

    Steel industry is partly shuttered, auto sector is in the process of losing thousands of more jobs, forestry sector is in free fall and has been for awhile, now we see oil and mining being affected by lay-offs.

    My question is this, is anybody in the private sector core industries going to receive a pay cheque in the next couple of months?

    We then will get even more of a ripple affect into the public sector.

    I am still not convinced that a deflationary spiral is as distant as some believe it is.

    The govt stimulus in Canada is a non-starter. We might get a bump from the US stimilus, but again, given the size of theoverall econmy, can this govt spending provide the shot in the arm to prevent a deflationary spiral.

    Also what in the private sector is on the horizon to prevent it from happening. It is more cutting, more lay-offs, more bankruptcies and credit defaults, and less alternatives being seriously considered.

    The US seems more and more to be trying to rebuild the past, rather than reaching for a new future. The past cannot be an option. Investment based upon, non-value adding financial investment is not something to wrap ones economic landscape around.

    Bottomline, without leadership, in Canada we are headed for the reef. And we still have policy makers believing and acting as though this is a mild downturn, and Canada will do just fine through this process. Well, potentially our banks will, but the rest of us, I am unsure on how this translation works for us working folk.

    Truly let me know what is coming to help turn this around.

    What I reckon from some of those I feel have a clue, is we have started falling less rapidly, but we have not hit the bottom yet. I am not so sure of this falling less faster, i.e. the second order has turned less negative.

    I am not convinced yet.

  • I always thought the BOC’s zero-inflation agenda was more about rejecting the phillips curve and asserting that they have no responsibility to think about unemployment. Of all the left-right continuums out there (of which I think there are dozens), one of the most important is the one where right wingers say inflation is more important than unemployment, and left wingers say the opposite. I think this whole issue of the BOC expressing continuing concern about inflation is just a right-wing bargaining posture, in lock-step with the ministry of finance. And they’re always the last to respond to any large-scale change in public opinion (and they’re proud of that).

    I’m surprised that you mentioned that wage increases are still ahead of inflation. I think in labour markets, things are “good” when wage increases exceed inflation, and things are “bad” when wage increases lag inflation. That’s aside from unemployment and problems with our social insurance systems. So if technically we’re still in the “good” side of this dynamic, there must be something else keeping wage increases up. Maybe the baby boomers are holding off retirement, maybe that labour shortage from a year ago is still working its way through the system, and maybe increases in education are still driving productivity and wage increases (just guessing here).

    And of course, the BOC has always had an eye on whether wage increases are driving continued inflation, and if they are, they’re always thinking of breaking labour’s back with a bit of unemployment here, a bit of an interest rate hike there. But strangely, the current environment is not having this impact.

  • Rather then being a threat, some deflation at this time could help restore some balance into the economy, no? In the bubble years, prices were overinflated, leading to above average profits for business. Lower prices on housing and food will help restore viable purchasing power to income ratios.

    As well, people will be able to pay off excessive debt and even build up a bit of savings, all of which are needed.

  • Deflation will help, but it will not happen, it’s too late, with this amount of money printed, it’s going to be hard, to survive inflation you might check this article:

  • It’s interesting to see that CPI is used to “measure” inflation. Consumer Price Index is a basket of goods that are measured periodically to determine the rise or fall in consumer prices. This is not inflation.

    Main Entry: in•fla•tion
    Pronunciation: \in-flā-shn\
    Function: noun
    Date: 14th century
    1: an act of inflating : a state of being inflated: as a: distension b: a hypothetical extremely brief period of very rapid expansion of the universe immediately following the big bang c: empty pretentiousness : pomposity
    2: a continuing rise in the general price level usually attributed to an increase in the volume of money and credit relative to available goods and services

    Prices rise when the money supply is changed relative to GDP. There will be periods when prices rise or fall temporarily, however those are corrected with supply/demand function. It’s impossible to measure something when the units we use are constantly changing. CPI is the unit we use to calculate inflation. CPI calculation has been changed over and over again through tactics such as hedonics, and substitutions. If the baskets of goods are being manipulated, is CPI a true measurement of anything? This would be like measuring the distance between Calgary and Winnipeg on year using kilometers. Then saying the distance between those two cities has changed the next year, but only because the distance you claim a kilometer measures is has changed.

    The true measurement and definition of inflation is the change in money supply relative to GDP. The monetary base of Canada and America are increasing much faster than GDP growth. There are a lot of temporary factors pushing certain prices down. Once those factors have been exhausted the monetary base will expand and without a doubt consumer prices will rise in proportion to the increased monetary base.

  • “Prices rise when the money supply is changed relative to GDP.”

    I would imagine if capacity shrank we would get inflation too. Imagine a general crop failure, in that case we would see an inflation in food prices even if the money supply remained the same. Inflation can be a monetary or a capacity driven phenomena. You would not argue unemployment had one cause so why inflation?

    “The true measurement and definition of inflation is the change in money supply relative to GDP”

    Ah that takes me back to the beginning of all this bullshit. Why? See above.

    “is CPI a true measurement of anything”

    It is a proxy nothing more, nothing less…kinda like the standard unemployment rate.

  • I think the definition of inflation quoted by Hank is a good one: “a continuing rise in the general price level.”

    If a crop failure increases food prices, that is a change in relative prices (food becomes more expensive compared to everything else) rather than inflation (prices in general increase). However, that does not mean that inflation can be defined or measured as “the change in money supply relative to GDP.” Increasing the money supply causes inflation only to the extent that the additional money is spent and only to the extent that this additional spending increases prices as opposed to output.

    If the economy is operating at full capacity, then more money means higher prices. However, if the economy is operating below full capacity, then more money can help facilitate more output without dramatically higher prices.

    Since inflation is about the general price level, the appropriate measure is a broadly-based index of prices, like CPI. Of course, CPI is not perfect. It tends to overstate inflation by overlooking the ability of consumers to substitute cheaper products for more expensive ones as well as improvements in product quality. The C. D. Howe Institute has a paper out this morning on that topic.

  • “If the economy is operating at full capacity, then more money means higher prices.”

    That is what I was trying to get at. There was a time when food prices were closely linked to wage rates such that crop failure could cause a general rise in the price level.

    My only point was that we could imagine for example a natural disaster which wiped out capacity and holding the money supply constant get inflation. But in that case inflation would not have a monetary cause. Inflation is not anywhere and everywhere a monetary phenomena.

    So sorry to hank if he was, indeed, not pushing monetarist dogma.

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