Insights at UBC Sauder

Werner’s Blog: Is inflation back to stay?

Werner’s Blog: Is inflation back to stay?
Posted 2022-01-26
It’s a hard reality to escape right now, whether you’re hearing it on the news or seeing it on the store shelves… prices are going up. But is it just a pandemic-induced one-off shock, or are these rising prices here to stay? In this excerpt from his latest blog post, Werner Antweiler, Associate Professor & Chair, Strategy and Business Economics Division at UBC Sauder School of Business, explores the current inflation in Canada, and predicts what the future may have in store.

News services reporting on the latest Statistics Canada data show that Canada's inflation rate has risen to a new 30-year high of 4.8 per cent. Is this rise in inflation here to stay or will it fade away quickly after economies have adapted more robustly to pandemic conditions? Will the rise in inflation move the Bank of Canada to raise interest rates?

To get a clearer picture about what is happening with prices, it is useful to decompose the Consumer Price Index (CPI) into “core,” food, and energy prices. Food and energy prices are particularly volatile, and thus they are typically removed from the analysis to focus on “core” inflation trends. By this measure, inflation just topped three per cent and thus exceeds the one-three per cent inflation target for the Bank of Canada.

Energy is notably volatile, with rates bouncing between minus 20 and plus 30 per cent. When the pandemic started, energy prices plummeted, but have since picked up pace. The price of crude oil is only slightly higher now than it was at the start of the pandemic.

The cost of food is also more volatile than other goods and services. Inflation rates vary between about minus two and plus eight per cent, and in December 2021 reached five per cent. However, this is only slightly higher than during previous peaks in 2011 and 2014, and less than during the 2008/09 recession. Also, at the beginning of the pandemic food prices dropped, and they are now catching up. Yet, the rapid rise in recent months, especially for imported fresh foods and fruits, has alarmed consumers.

It is perhaps too early to panic about inflation, but yes, there are worrisome signs that inflation is heating up in certain areas. I fully expect the Bank of Canada to start raising interest rates gently during 2022 in order to signal that it is prepared to act more forcefully if needed. What we need to worry most about is whether the current burst of inflation leads to a spiral of higher wage demands, that in turn translate into higher consumer prices. The most important task for the Bank of Canada will be to manage inflation expectations. If these expectations change, it will have significant repercussions throughout the entire economy. Even transitory inflation can cause lasting harm, as C.D. Howe Institute economist William Robson pointed out. Looking at a measure of inflation that smoothes the pandemic volatility, the 24-month inflation figure hovers just below the three per cent threshold at which the Bank of Canada will be compelled to act.

What is driving inflation is a combination of several effects. First is the excess volatility from the pandemic. Prices dropped, then rose sharply. Thus, for food and energy one needs to carefully compare prices with pre-pandemic levels and trends. The cost of energy, as measured by the price of crude oil, is roughly in line with 2018-2019 rates of 50–80 USD/barrel. What is more worrisome is the change in supply and demand conditions. Because people have been spending less money on services, which have been less available since the start of the pandemic, they have been spending more on durable goods. This has driven up prices for a variety of such items including cars, appliances, and furniture. At the same time, we have seen shortages in production (e.g., computer chips) and especially transportation. The supply-demand imbalance has the predictable effect of increasing prices.

There is, however, a bit of good news out west: a look at inflation trends in three Canadian provinces over the last four years: British Columbia, Ontario, and Quebec, shows that British Columbia’s inflation is rising less rapidly than in Central Canada. Inflation in Ontario in December 2021 was 5.2 per cent, compared to only 3.9 per cent in British Columbia.