A Tale of Two Inflations: Canada vs. Ontario

Today’s Consumer Price Index release told a tale of two inflations. The national rate decreased from 1.8% to 1.7% while Ontario’s inflation rate remained at 2.9%, the highest in Canada.

Monetary Policy

Of course, monetary policy should reflect the whole country. The national inflation rate decreasing to 1.7% in August begs the question of why the Bank of Canada has increased interest rates three times in a row. Higher interest rates are supposedly needed to control inflation, but there does not appear to be much inflation to control.

Although 1.7% is below the Bank of Canada’s 2% target, it actually overstates inflation by comparing post-HST prices in August 2010 to pre-HST prices in August 2009. Price increases from one-time tax changes should not guide monetary policy. Factoring out the HST’s introduction in Ontario and British Columbia would reveal a lower national inflation rate and even less justification for interest-rate hikes.

Compensation Policy

Given the HST, it is not surprising that Ontario inflation significantly exceeds the national average. It is ironic that the government of the province with the highest inflation rate has been among the most aggressive in proposing to freeze public-sector compensation.

Most provincial governments have been negotiating very modest wage increases with their employees. By contrast, the Ontario government is requesting a two-year freeze, which entails an appreciable pay cut relative to inflation. Reducing the purchasing power of the more than one million Ontarians employed in the broader public sector would be a drag on the provincial economy.

5 comments

  • Apart from inflation expectations, I can imagine another reason not to keep interest rates artificially low.

    Really, really, really low interest rates did not have the desired affect. Rather then increasing business investment, it fueled excessive consumer debt. Not a good situation for working stiffs.

    Current rates are still really, really low. Plenty low enough to act as economic stimulus. But business is still not stepping up to the plate.

    So they had their chance, and they blew it.

  • BC also introduced the HST, but our CPI grew by only 1.5% between August 2009 and August 2010, below the national average (though in all fairness, the average is considerably pushed up by Ontario’s 2.9%). Is that because businesses in BC are that much more competitive and immediately passed on their HST savings by lowering their pre-tax price?

    All in all, inflation doesn’t seem to be a pressing problem for Canada at this point and I agree that we don’t need to be reducing the amount of monetary stimulus in order to pre-empt high inflation.

  • But unlike BC, the Ontario HST applies to electricity, natural gas, and gasoline. Perhaps the difference can be explained by these differences.

  • the bank of canada didn’t up the interest rate to curb inflation, but to be coy about u.s. growth expectations while encouraging speculation on the canadian dollar in international money markets. the announcement of the third hike immediately led to a rise of an entire cent of the canadian relative to the american dollar. the bank was hedging itself against further decline in u.s. recovery, but since then, the mere promise that the fed would guarantee more bail-out money in the form of bond-purchases has provided a temporary artificial boost, causing the cdn $ dollar to plunge again leading most speculators to believe that the bank will hold the rate steady for the rest of the year.

  • BC’s carbon tax on the items identified by Michael increased at the same time as the HST was introduced. The HST and carbon tax increased BC’s price level (2002 = 100) from 113.4 in June to 114.6 in July and 114.5 in August.

    Perhaps Bill Vander Zalm spooked BC businesses into slightly reducing consumer prices between July and August. But the main reason BC’s annual inflation rate decreased in August 2010 was that the base of comparison increased. BC’s price level had risen from 112.4 to 112.8 between July and August 2009.

    Note how much BC’s annual inflation rate fell despite almost no reduction in current prices:
    114.6/112.4 = 2.0 %
    114.5/112.8 = 1.5 %

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