Inflation targeting has been the cornerstone of monetary policy in Canada since 1991. The Bank of Canada aims to keep inflation rates at the 2 per cent target, the midpoint of the 1 to 3 per cent inflation-control target range.
Since 1991 that is exactly what has occurred, as inflation rates have averaged out to be 2 percent per year over the past 20 years. But in December 2010 the total Consumer Price Index went up by 2.4%, leading many to believe that rising inflation is becoming a serious threat.
Inflation Rates: Are Things Really That Expensive?
Rising prices really get people worked up in our society, and rightfully so. It means more money coming out of your budget each month for essential purchases and less money available for savings and discretionary purchases.
We love to complain about the prices at the pump, the cost of chicken at the grocery store, and our monthly cell phone bills. But are things really that much more expensive than they were 5 years ago? Are you better off now than you were 5 years ago?
I find it interesting that when prices are falling we don’t make such a big deal but when prices are rising it seems like there is no end in sight. How often did we hear about the price of oil going to $200+ per barrel back in 2008 when gas prices hit a record high of $1.42/litre in Canada? But later that year prices at the pump fell sharply down to $0.73/litre and we barely noticed.
The average Canadian gas prices in the Spring of 2006 were exactly the same price as they are today, at roughly $1.13/litre. Meanwhile how much has your income risen over the last 5 years?
It’s Volatile But Not Out of Control
People are more familiar with the volatility of the stock market since they see these charts more frequently than commodity price indexes. Yet the same patterns emerge within commodities markets, so we have to expect similar peaks and valleys as we do with the stock market.
Yes, the cost of certain commodities have risen substantially over the past few years, but that doesn’t mean that our standard of living has diminished just because the price of coffee has doubled. But the doom-and-gloom forecastor’s would have you believe that we’ll be rationing our cans, standing in line for bread, and rioting in the streets.
Financial Uproar posted an article about how food prices are rising, but that most people would barely notice in North America since food does not make up a huge part of our monthly budgets and because companies are cleverly packaging their product at lower weights. This is true, especially here in North America.
We take it for granted that our expenses for essentials are cheap compared to other parts of the world, and especially compared to our incomes. We’ve had some tough economic times here lately, but I would guess that the majority of working Canadians’ wages have risen by at least 10% over the past 5 years to keep up with inflation.
It’s Not Inflation That We Need To Worry About
The Bank of Canada is in a difficult situation right now because in order to keep inflation rates from moving above the target rate of 2 percent they will need to increase the overnight lending rate. This triggers interest rates to rise and the dollar to go up, then causing a decrease in demand which leads to lower production, and results in lower prices.
The problem is, interest rate hikes will aggravate 2 additional problems – the exchange rate and the real estate market, both of which are critical to the continued economic recovery.
The Bank of Canada will continue its monetary policy of keeping inflation low, stable and predictable. So while Mark Carney stick handles his way through this economic recovery, we shouldn’t worry so much about the rising inflation rates. What we need to be concerned about is the effects of containing inflation by raising interest rates, and how it will impact the exchange rate and our housing market.