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FINLAYSON: Taming the inflation monster

‘Canadian policymakers should support the Bank of Canada’s efforts to get inflation back to 2 per cent’
Jock Finlayson is a senior policy advisor with the Business Council of British Columbia.

After growing comfortable with a long stretch of relatively low and mostly stable inflation since the mid-1990s, Canadians today are grappling with a worrisome and unexpected surge in the Consumer Price Index (CPI).

The pressure on prices started to build early last year, and inflation has steadily gained momentum since then. By April 2022, total CPI inflation in Canada stood at 6.8 per cent – meaning the overall cost of living is almost 7 per cent higher than one year earlier. Inflation is expected to inch higher in May, thanks in part to still rising fuel prices.

To purchase the same basket of food, energy, housing and transportation services, and other consumer items that cost $100 a year ago, Canadians must now shell out $107. That figure is likely to reach at least $110 by the end of 2022, as there are few signs that inflation is abating.

Three factors help to explain the surging prices currently confronting Canadian households and businesses.

The first is the series of “supply shocks” triggered by the ongoing global COVID-19 pandemic and, more recently, by Russia’s invasion of Ukraine. These have disrupted manufacturing supply chains (particularly those linked to China), fostered turbulence and escalating prices in energy markets, and pushed up the cost of transporting goods.

The Russia-Ukraine war has stoked the pre-existing inflation problem by reducing agricultural output and exports from these important food producing countries.

The second contributing factor is the stimulative monetary policy adopted across much of the world since the Global Financial Crisis of 2008-09 – a policy stance that received a further boost when central banks slashed short-term interest rates to near zero and injected vast amounts of money into the financial system when COVID-19 arrived in early 2020. In Canada, almost two years of record low borrowing costs fueled frenzied activity in housing markets, led to dramatic increases in house prices, and encouraged consumers to accelerate purchases of big-ticket items – all of which aggravated inflation.

Finally, in some jurisdictions, including Canada, government fiscal policies have also played a role in propelling inflation. When COVID first hit, governments appropriately provided generous financial support to workers and businesses hurt by the restrictions introduced to contain the virus.

This resulted in enormous government deficits. However, the economy bounced back quickly in the second half of 2020, with the positive momentum extending through 2021. Both Canada and B.C. have seen economic activity more than fully recover from the brief COVID recession of 2020, and the job market is drum tight.

Despite presiding over an economy running flat out amid runaway inflation, the federal government is still planning for a hefty $50 billion deficit in the current fiscal year, while the Horgan government is projecting another $9 billion of red ink. It is hard to see any justification for large government deficits in the present macroeconomic climate.

While governments are spending as if the economy was still moribund, the central bank is now engineering substantial interest rate hikes to temper demand and, hopefully, stem inflation. Fiscal and monetary policy are at loggerheads, which suggests interest rates may need to be pushed even higher as the Bank of Canada acts to tame the inflation monster.

How will all of this affect consumers? Those looking to obtain new or renew existing mortgages will find that borrowing costs are markedly higher than 12 or even six months ago. Auto loans and prime lending rates have also moved higher and will probably continue to do so for a while yet.

On the other hand, long-suffering savers can look forward to somewhat better rates on savings accounts and GICs. However, with the Consumer Price Index climbing at an annual rate of 6-7 per cent, savings and investment products offered by financial institutions still yield deeply negative returns when measured on an after-inflation basis. And even workers who receive pay increases will discover that their “real” earnings are failing to keep up with rising living costs.

Canadian policymakers should support the Bank of Canada’s efforts to get inflation back to the longstanding 2 per cent target that the Trudeau government reaffirmed last year. In the meantime, if politicians want to help consumers navigate the inflationary storms, one simple option is to introduce temporary cuts to fuel taxes – although such a measure would add to government deficits in the short-term.

Jock Finlayson is a senior policy advisor with the Business Council of British Columbia.