Inflation, Wages and Monetary Policy

This morning, Statistics Canada reported that the annual inflation rate rose to 1.8% in April.

Inflation and Wages

While inflation remains low, it is eating up almost all of the modest wage increases that workers have eked out over the past year. The Labour Force Survey indicates that the average hourly wage rose by 2.0% between April 2009 and April 2010. With 1.8% inflation, purchasing power only improved by a meagre 0.2%.

Inflation actually exceeded wage increases in three provinces. In Ontario, a 1.7% rise in the average hourly wage fell short of 2.2% inflation. Prince Edward Island parallelled Ontario with a 1.7% wage increase and 2.3% inflation. New Brunswick posted the worst numbers, with a 1.4% wage increase falling well below 2.9% inflation.

The problem is that wage increases have been weak. Government policies like Ontario’s attempted compensation freeze for the broader public sector threaten to aggravate this problem.

Inflation and Interest Rates

With inflation still below the 2% target, there is little apparent justification for the Bank of Canada to raise interest rates on June 1. Also, April’s 1.8% inflation was largely driven by higher energy prices. But we know that the price of oil has since dropped by some 20% from its April peak.

The core inflation rate, which excludes volatile prices like energy, was 1.9%. Again, this rate is below the 2% target.

The sensible policy would be to leave interest rates where they are for now. As I noted regarding the previous Consumer Price Index release, it is unclear why the Bank of Canada removed its conditional commitment to not raise rates before July. Fortunately, the central bank has not actually committed itself to raise rates on June 1.

4 comments

  • I do wonder what statement the BoC will make on June 1 with regards to interest rates.

    I also wonder if any kind of connection can be established between the downturn in Europe, its affects on Chinese exports to the EU and the consequent reticence from China to drop its peg on the dollar, and any affects that may have on the U.S., and, subsequently, Canada. A bit of a roundabout interpretation, but I can’t help but wonder about this level of interconnectivity.

    As a complete amature on these matters, I would love some RPE opinion on the level of global interdependency as it relates to Canada!

  • Does the BoC care about wages directly? If other factors appear to be increasing the risk of higher inflation a few months down the road, then would not the BoC ignore even failing wages?

  • A lot of figures about the average wage. I don’t trust average wages as an indicator in our society; the top always seems to clean up while the lower end if anything loses ground. Any notions where the median was going?

  • The world is still more vulnerable to deflation than inflation. And there’s nothing better for preventing deflation than increasing nominal wages (which are the most important nominal benchmark on which the overall price level can “hang”). That’s why doing things like higher minimum wages and strengthening collective bargaining structures make excellent sense from the macroeconomic level, not just the social angle.

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