This text is taken from Courrier de l’économie. Click here to subscribe.
A recent analysis of inflation in history indicated that the historical median for inflation to drop from 8% to 3% is 10 years. Louka Kattan Méthot’s question is therefore: what leads most analysts to believe that inflation will quickly come down to a level close to 2%, whereas historically it has not often been case ?
Simply put, the author our reader cites observed that a jump in inflation to 4% is often temporary, but when inflation rises above 8%, it jumps to higher levels more than 70% of the time. If inflation peaks at 4 or 6%, it halves in about a year. If it is accelerating, inflation of 6% drops to 3% in a median of about 7 years. Getting back to 3% inflation from 8% or higher usually takes 6 to 20 years, with a median of over 10 years.
This historical perspective must be qualified. Starting from a level of 3% at the beginning of 1970, inflation soared to reach an average of almost 11% observed at the beginning of the 1980s. a sometimes strong rise in central bank interest rates. Without returning to the 3% level, but to stay around 4%.
However, in 1991, the Bank of Canada adopted a policy of targeting around 2%. During the 30 years that followed, inflation remained within the target range of 1-3% (except for four or five small overshoots, including one below the lower limit of 1%), until April 2021. You know the rest.
We also need to focus on what fuels inflation. The effects of excess demand are easier for a central bank to counter than a supply shock (such as the difficulties encountered in the supply chain) or exogenous (such as the oil shock of the 1970s or the impact of the Russian war in Ukraine on the prices of basic and energy materials).
Beyond the target, the Bank of Canada is working to keep inflation low, stable and predictable. In the current economic climate, it wants to avoid unanchoring the inflationary expectations of households and businesses, which could lead to a wage-price spiral and fuel self-fulfilling inflation that is difficult to extinguish. Currently, long-term expectations are hovering around target.
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