Inflation: A Paper Tiger

The obvious headline from today’s Statistics Canada release is inflation rising to 1.3% in December, its highest level in almost a year. However, the Consumer Price Index actually decreased between November and December. The overall price level was down 0.3% in absolute terms and 0.1% on a seasonally-adjusted basis.

The annual inflation rate rose only due to a lower base of comparison. In other words, consumer prices had fallen even more between November and December of 2008. Going back a little further, the Consumer Price Index is still a full point below its pre-crisis peak (114.8 in December 2009 versus 115.8 in July 2008).

The Bank of Canada’s core inflation rate remained level at 1.5%, well short of the 2% target. Today’s data validates the central bank’s decision to keep interest rates at rock-bottom levels. The prospect of having to raise rates to quell inflation is far away.

On the contrary, the Bank of Canada should be contemplating monetary expansion to quell the Canadian dollar’s excessive rise. The loonie has recently run up above 96 US cents, the level envisioned by the last Monetary Policy Report.

The OECD’s most recent figures on purchasing power parity indicate that the Canadian dollar should be worth 86 US cents. That level would be far more conducive to a recovery of output and employment in Canada’s export industries.

UPDATE (January 21): Quoted by Bloomberg

One comment

  • Hi Erin,
    Not sure what you are suggesting re monetary expansion with the overnight interest rate at 0.25%.

    I think the low inflation rate indicates there is plenty of room for additional federal government spending. I would propose more spending for the unemployed, native people, increases to OAS/GIS, a national pharmaceutical drug plan, high speed trains, public transport, to name a few.

    The resulting excess settlement balances in the banking system could be drained by the emission of 3 year bonds (currently at 1.75% interest) or not be neutralised at all and allowed to accumulate in the banking system at the 0.25% floor interest rate currently paid by the Bank of Canada. The latter would mean no increase in the level of federal government debt.

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