Where’s the Inflation Bogeyman?

Mark Carney saw a bogeyman on Tuesday morning. He was spooked into removing his conditional commitment to hold interest rates, which would otherwise have expired at the end of June. By signalling that it might raise interest rates ahead of schedule, the central bank drove the Canadian dollar from 98 US cents on Monday to 100 US cents on Tuesday.

Higher interest rates are supposedly needed to control inflation. But there is little evidence of that threat. This morning, Statistics Canada reported that the national inflation rate fell from 1.6% to 1.4% in March. The core rate, closely watched by the central bank, dropped from 2.1% to 1.7%.

The Olympics had boosted February’s inflation figures. With that event over, both measures have predictably dipped back below the 2% target.

Obviously, the Bank of Canada will raise interest rates at some point. However, it is unclear why it opened the door to raising rates in June instead of July.

This unnecessary rush had the negative effect of driving up Canada’s already overvalued currency. The latest OECD figures on purchasing power parity suggest that a Canadian dollar should be worth only 86 American cents. Having it 14 cents above fair value imposes a huge cost on Canada’s beleaguered export industries.

Importantly, the Bank of Canada has not actually committed to raise interest rates in June (it just removed the commitment to not raise them). Based on today’s cool inflation numbers, it could partially redeem itself by holding interest rates steady in June. Doing so could help temper the lofty loonie.

Regional Picture

In recent years, the typical pattern has been relatively high inflation in western Canada’s robust resource economy and lower inflation elsewhere. In March, prices actually declined in the westernmost provinces and increased most on the east coast.

As a result, provincial inflation rates now look like a staircase, rising from west to east. The inflation rate is only 0.5% in BC, 1% in Alberta and Saskatchewan, around 1.5% in central Canada, and about 3% in the Atlantic provinces.

UPDATE (April 24): Quoted by The Toronto Star and Reuters


  • Great informative piece.

    Nipickingly, however, “to commit” is a transitive verb, so while many people use it the way you have above — “Importantly, the Bank of Canada has not actually committed to raise…” — it is better to write: “the Bank of Canada has not actually committed itself to…”

  • I would underline your point Erin, the BOC in threatening to raise rates has just railroaded any notion of the loonie coming down any time soon.

    In so doing, the Tories have proven they have no notion of developing a strategy towards helping manufacturing and forestry sectors recover in this country. Again I will state this, a high dollar is not a problem, as long as it is a long gradual slope of increase. The graph for the dollar compared to other currencies is looking more like the trails of exploding particles coming out of the Large Hadron Collider.

    Talk about putting the brakes on the econoy.

    The high loonie is alone doing enough to slow the economy down, but raising rates, and then bringing Stockwell “where’s my axe” Day and the rest of the lets beat on the public sector workers and public expenditure crew- it won;t be long before we are back into a whole lot more economic carnage.

    This of course on a stage where employment is still quite unacceptably high and the quality of employment growth, as noted by the rise in Self employment and part-time work is much too precarious.

    This is a real antedote for disaster and I do think without some kind of Greek response to the situation, these policies will continue to beat upon the workers of our country.


  • Peter Alexander

    In my very brief formal study of economics I recall vividly the concept of the “Philips curve” which describes the inverse relationship between inflation and unemployment (high inflation decreases unemployment, and low inflation increases it). Yet I almost never read mention of the impact of inflation on unemployment. I am not advocating for rampant inflation by any means, but the difference between an inflation target of 2 to 3% and a target of, say, 4 to 5% would apparently be significant for job creation. And the zealotry of the BOC under John Crow to achieve zero inflation really hurt economic recovery. Of course if you are a creditor (bank), you loathe the idea of an increase in inflation — that devalues your loan portfolio in real dollars. (I guess I’m wondering if the Philips curve concept has been discredited or something??)

  • Good post Erin. I do not see a significantly higher interest inflation rate regime evolving any time soon. I put a post up earlier today so I will not elaborate. One thing I did find curious was his acknowledgement that growth was going to be anaemic which he did not square with his view of inflation. It would seem as though he is worried about imported inflation. But if that were the case how does increasing rates in Canada solve the problem unless he is counting on an appreciation of th CDN $ to tamp down imported inflation. This would indeed be a very punitive inflation solution for the manufacturing sector.

  • It sure would be a long day if Nitpicker went at my grammer and spleelling

    gees Erin they are on to you!

    One of the oddities that jumped out at me was the decline in shelter costs. Given the apparent rampant run up in the price of housing, one would have thought those shelter costs might have displayed at least a similar direction. (the shelter quantification is a bit complicated but it does include a large component of owned accommodation.)

    An add on to this, some have stated that the interest rate hikes are in part being driven by the notion that a housing bubble is building up and a bit of a hike in rates may cool this speculative bubble off. If that is part of the rational of these hints at rate hikes, one has to ask, at what cost? And if, as some have stated that credit is driving the economy .i.e. rapidly building home equity, how does raising rates solve such a problem.

    The cost of raising rates just after a recession that ultimately may still be lingering in recession, given the dynamics of the employment markets, only results in additional unemployment due to the higher dollar effect on the export markets and also to the higher price of credit.

    So it is extremely unclear to me how this misguided attempt at using monetary policy is going to be effective at anything but creating more unemployment.

    If they want to contain the housing bubble, there are alternative means to accomplish such goals, other than trashing the entire economy. Phrack!

    However according to the CPI data their is no rise in housing prices , in fact, overall we have a decline.


  • oh and I forgot to add,

    what happens when oil starts its typcial summer run up in prices, we all know what effect that has on our dollar. I wish the BOC would be a whole lot more cautious with its shift of gears and rethink these signals and coming actions.

    However, given that the banks have already been raising rates, one does wonder does it really matter what the BOC does?

  • Good point, Peter. The Bank of Canada would deny the existence of such a Phillips curve and would also deny any responsibility for unemployment. It claims that the only goal is inflation control. By comparison, both “maximum employment” and “stable prices” are official goals of American monetary policy.

  • Well I might deny the existence of the Phillips curve given it has as much scientific merit as the NAIRU if thought of in covering law like terms. Let us not go fetishising itinerant bedfellows as causal laws.

  • i think I need to restate that one point above, as it is not that clear now that I read it.

    On the one hand we may have a run up in credit due to housing prices and rising home owner equity. (not sure on the quantities here but given stagnant wages, it is the about the only source, other than more short term credit creation, of consumption within the economy).

    So as stated, if the credit creation bubble is what is creating a large proportion of demand, given we are falling victim to more unemployment and decreasing consumption from actual earnings generated from pay packets- how do we get from credit based growth to employment based growth by a misguided raising the rates monetary policy? Is this not a paradox? Raising the rates will put the breaks on low cost credit and should also slow the housing bubble (to what degree who knows), but it also creates unemployment by external forces, i.e. raising the dollar in short bursts that decrease exports and further pressuring whats left of the manufacturing, forestry sectors, and the high value adding service industry. Given that payrolls will be hit with another series of declines and the multipliers to the rest of the economy start lashing back at unemployment, bring home grown consumption down. This also out a break on our credit based consumption which again feeds into unemployment. And the third pillar is the pressure on public expenditure as the shift to deficit fighting and reduction of stimulus again bring the wrong arrows into the heart of employment.

    So is raising rates not just about the worst thing we can do right now. Should the BOC not wait until we start to see a bit more of a recovery in terms of employment growth.

    Sorry if I am repeating myself but I was trying to straighten the above out.

    hmmmm… they do have such strange people working at the BOC as I simply cannot find a reason for raising rates or even contemplating the thought.

    I do believe they really blew it at the bank and just threw a few more canisters of petro into the fire to destroy said recovery. I guess my problem is the question- recovery for who.

    I got to quite pretending that Harper actually cares about the working people of this country, sorry my mistake.

  • Peter Alexander

    Thank you, Erin. Good point re Non-Accelerating Inflation Rate of Unemployment (NAIRU), which is a rare, bald expression of how jobless folks are not just tolerated by capital but seem to have a “helpful” role in keeping inflation low (hands up if, like me, you’ve ever taken a hefty cut in pay just to get back to work). Re US policy framework, I naively believed Bank of Canada statutory framework mandated a balanced approach to inflation and unemployment. Time for me to go read some legislation, methinks… Thanks again Erin.

  • You are correct about the Bank of Canada Act. However, Canadian central bankers have since redefined their mandate. The US Federal Reserve still defines employment as part of its mandate.

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