From the outset, the recent surge in inflation was largely the result of factors beyond the Bank of Canada’s control. But that was no reason to do nothing, if only to reassure Canadians of his seriousness in the matter.
The Canadian central bank raised its key rate by another quarter of a percentage point on Wednesday. Since last March, the institution has thus raised its main monetary policy tool from the floor level of 0.25% to 4.5% and, with it, the interest rates for mortgages, lines of credit and other forms of loans available to consumers and businesses in Canada.
The objective of the maneuver is obviously to bring inflation into line, which, after having plummeted during the first months of the COVID-19 pandemic and the suspension of several economies, has raced to its peak. to 8.1% last June. The idea is that by making credit more expensive, we will reduce the demand for goods and services and then, by extension, their prices. This monetary curb already seems to be yielding results, since inflation had returned to 6.3% in December.
This achievement is all the more remarkable given that the Bank estimates that it “usually takes 18 to 24 months for the effects of such adjustments to be fully transmitted to the economy”. It must be said that this improvement is not only the result of a decrease in demand for durable goods in Canada, which is particularly reactive to interest rates, she noted. It also stems in large part from lower global energy prices and faster-than-expected improvements in global supply chains, factors over which its interest rates have no control.
The Bank now says it wants to “pause” to see how the situation develops. However, it says it is ready to return to the charge with further interest rate hikes if necessary.
Inflation like no other
She has already done enough, and maybe even too much, National Bank analysts said Thursday. Two of them took the opportunity to publish a short study seeking to measure the share of inflation attributable to the strength of demand — which the Bank of Canada’s rate hike seeks to curb — and that which comes from supply problems linked in particular to global factors, such as the war in Ukraine and health policies in China.
To do this, economists Alexandra Ducharme and Matthieu Arseneau drew inspiration from a method developed by the San Francisco Federal Reserve which is based on what economists call the consumption deflator rather than the usual index of consumer prices (CPI). This measurement has the disadvantage of only being taken every three months, but has the advantage of revealing, among other things, that the average inflation suffered by consumers last spring was not 7.6%, but 6.1%. This is because, unlike the CPI’s reference basket, which always remains the same, Canadian households have substituted certain goods and services to adapt to their price variations.
Above all, we see that the influence of supply problems on annual inflation has tripled compared to its historical average from autumn 2021. On a quarterly basis (see graph), we see that at the same time , demand has played a growing role, which suggests that the economy is overheating somewhat, but that it had become a negligible factor again in the third quarter of 2022, the last for which we have figures. Meanwhile, external inflationary pressures from the supply side remained strong, observe Ducharme and Arseneau, particularly with regard to food, gasoline and vehicle parts.
The surge in inflation that the world has experienced in recent months bears little resemblance to what we have seen since the end of the Second World War, explain experts from the Bank of Canada in an analysis released Thursday . It is largely the consequence of the monster disruptions in production chains and household demand caused by the pandemic and Russia’s invasion of Ukraine.
Make an impression
These external shocks may have accelerated deeper changes that will have a more lasting effect on prices, such as a decline in globalization, rising retirements in aging populations, or the costs of shifting to a greener economy. But for the rest, one would have thought that it was only a bad time to pass and wait for the situation to return to normal.
This would be to ignore the fact that if consumers and businesses were not paying attention to inflation during the long period when it was below the Bank of Canada’s 2% target, in the aftermath of the last crisis financial, it is quite different now that it exceeds it blithely, observe the experts of the Bank of Canada in their analysis.
According to one theory, they are “rational actors” to whom we can explain the particular context in which we find ourselves and who will not raise their prices or demand wage increases knowing that inflation will eventually return to normal, explained in a speech in September one of the deputy governors of the central bank, Paul Beaudry. This is what central bankers call anchoring expectations.
Another theory is that they will quickly mistake the acceleration in prices and wages for the new reality and it will take a lot more than simple explanations to change that. This is known as the danger of “unanchoring expectations”, which requires, among other things, that interest rates be raised to show that we are taking the matter seriously.
“The truth, as you can imagine, lies somewhere between these two theories,” the Deputy Governor concluded.
He will be one of those involved in deciding whether to continue, halt or reverse the Bank of Canada’s interest rate hike in the coming months.