Latest inflation numbers may be sign of things to come

Canadians are facing sharp increases in the prices for goods and services. According to a recent report from Statistics Canada, the country’s annualized monthly inflation rate reached 4.8 per cent in December, the highest rate since 1991. There’s a serious risk Canadians will endure sustained inflation—not transitory, as some experts have predicted—as consumer expectations shift, supply chain issues persist, and the money supply continues to expand.

In simple terms, inflation occurs when the demand for goods and services exceeds the capacity of the economy to meet that demand at existing price levels. Currently, Canadians face growing costs for food, energy, rent and many other essential goods. For instance, national prices have increased by 9.0 per cent for meat, 3.1 per cent for dairy products and eggs, and 5.2 per cent for food overall in the last 12 months (December 2020 to December 2021) of available data. Gasoline prices have also surged by 33.3 per cent over the same timeframe. With prices increasing, daily life has become increasingly expensive for Canadian families.

However, the latest inflation numbers should not come as a surprise. Last spring, officials in the Department of Finance warned the federal government that “runaway inflation” was a real possibility. Despite this warning, the federal government continued to characterize surging inflation as both a temporary and global phenomenon, inferring that Ottawa could take only limited action to reduce it.

But in reality, higher inflation could be longer lasting and particularly harmful, especially in Canada. The International Monetary Fund (IMF) forecasts Canada will have the fourth-highest inflation rate among 35 industrialized countries in 2021, behind only the United States, Iceland and Estonia. In other words, while inflation may well be a global problem, Canada’s inflation rate is among the highest of any industrialized country. Economic forecasters also expect inflation rates to remain near current levels throughout 2022.

Also, supply chain disruptions and labour shortages continue to plague the Canadian economy. Consequently, businesses are unable to meet consumer demand for goods and services, which will keep pushing prices upwards for the foreseeable future. Moreover, if consumers grow to expect higher rates of inflation, then workers will begin demanding higher wages and consumers may begin panic-buying to avoid future price increases. A surge in demand for goods today, when supply is already limited, will drive prices higher and exacerbate the problem, potentially creating an inflationary spiral. Put simply, the expectations of increasing inflation among consumers can, on its own, fuel longer-term inflation.

Finally, the Bank of Canada will face political pressure to maintain low interest rates to continue financing high levels of government spending. Specifically, supporters of ongoing expansionary monetary policy may call for the bank to continue purchasing government bonds to help fund Ottawa’s spending, which includes income support programs and green energy initiatives.

While the Bank of Canada has largely curtailed short-term lending to the government (i.e. T-bills), it’s still financing Ottawa’s long-term debt, as it held $434.6 billion in Government of Canada bonds as of December. To put this in context, the bank only held $76.5 billion of these government bonds before the pandemic began in March 2020. Sustained inflation could become a reality if the bank continues to finance this government’s spending.

Inflation remains a serious risk that should be a focus of concern for policymakers. Canada has one of the highest inflation rates in the developed world and several signs suggest this issue is not going away any time soon.