Deflation Continues

This morning’s consumer price figures for August are reminiscent of July. The annual Consumer Price Index decline was 0.8% (compared to 0.9% last month.) With the exception of July, August was the sharpest drop in consumer prices since 1953.

In both July and August, eight of ten provinces posted negative inflation rates. The only province with positive inflation in both months was Saskatchewan, where the cost of living continues to rise.

As in previous months, negative inflation reflects lower gasoline prices in 2009 versus 2008. There is little evidence of a generalized decline in prices that could greatly prolong the recession through a deflationary spiral.

Core inflation, the Bank of Canada measure that excludes gasoline and other volatile items, is still positive. However, August was the third consecutive month in which the core rate decreased. This fact suggests that the underlying inflation trend is downward rather than upward.

Lower core inflation has implications for monetary policy. In its last interest-rate announcement, the Bank of Canada alluded to quantitative easing – “the framework outlined in the April MPR” – as a possible response to the soaring Canadian dollar. This morning’s numbers confirm that it has room to make such an intervention without spurring excessive inflation in Canada.

Today’s numbers also bear on the deficit debate. Some commentators have argued that the Fiscal Update should have been more aggressive in balancing the budget. A significant rationale for reigning-in fiscal stimulus is to avoid stoking inflation. However, inflation does not appear to be a major threat.

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