Post mortem: “The best remedy for high prices is high prices”

Kevin Carmichael: Inflation is a concern, but it’s too early to panic. We have been here before

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FP Economy Editor-in-Chief Kevin Carmichael unpacks the week in Economics.

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Soaring prices

Journalists have access to time machines. When we want to pick you up, we remind you of what you have been listening to for a while. Inexpensive, but effective. So here we go: remember The ketchup song by Las Ketchup? We didn’t, but Wikipedia complaints it was the biggest song in Canada the last time inflation was as hot as in august.

New evidence of soaring cost of living ablaze on the country pathBut policymakers, who need to know there is little they can do about inflation in the short term, quickly reverted to simpler attacks. Statistics Canada’s Consumer Price Index (CPI) is now increasing at an annual rate of 4%, and the Bank of Canada’s inflation target is 2%, so we are in risky territory. Yet Governor Tiff Macklem was ready for it: The latest central bank forecast predicted the CPI to average 3.9% in the third quarter. The central bank would not have panicked.

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Prices are still being manipulated by strange pandemic effects. The latest figure was influenced by gasoline, which rose more than 32% from August 2020, when fuel costs were depressed by the COVID-19 recession. Gains of this size will not continue. Bay Street Economist David Rosenberg observed last week that supply has caught up with demand for most commodities, and therefore the price of raw materials now represents a disinflationary force. “As they say, the best remedy for high prices is high prices,” Rosenberg wrote with his colleague, Marius Jongstra.

March 2003 marked the end of a four-month streak of inflation above four percent. (It was also the peak of Las Ketchup’s fame in North America.) The year-over-year increase in the CPI fell to 2.9% the following month. Inflation is a concern, but it is too early to panic. We have been here before.

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Home truths

The Conservatives want you to think of the price dynamics after the pandemic as “Justin Trudeau’s inflation.” There is something to this. The main driver of inflation is the mismatch between supply and demand. Trudeau and nearly every other ruler in a wealthy country have deployed unprecedented levels of stimulus after shutting down their economies to stop the spread of COVID-19. But many companies have neglected to update their recession strategies to account for the possibility that governments may be prepared to guarantee demand in the short term. Households had cash on hand, but producers had retreated in anticipation of a disaster. Supply still has not caught up, creating a shortage. You don’t have to be an economist to know what this means.

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By blaming Trudeau for the inflation explosion this summer, you are saying you think his COVID-19 bailout was too generous because he left too much money in households to hunt too little property. It also means you would have preferred the natural outcome of a recession that aggressive fiscal stimulus avoided: a prolonged period of disinflation and potentially deflation. Choose your poison. Most mainstream economists believe the United States, Germany, Canada and others were too quick to switch to austerity after the Great Recession. The rich world chose to do things differently this time.

The cost of living is generally cheaper than you might think. We often hang on to the price of the goods and services we buy, rather than the full basket of our needs and wants. Headlines and chatter are also influential. So even though very few of us regularly buy homes, our view of inflation is still influenced by house prices. We are obsessed. That’s why, when the National Post wrote about how the August CPI numbers played out during the election campaign, he focused on the sub-index which measures what it would cost owners to replicate their current situation. The Homeowners’ Replacement Cost Index jumped 14% from August 2020, the highest since the late 1980s.

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And yet, the overall cost of owning a home is increasing at about the same rate as in 2008 (graph below). This is because mortgage deflation almost perfectly compensates for price inflation. Perhaps the only thing the new government could do in the short term to curb inflation would be to relieve some pressure on the housing market. They could do this by using their regulatory power to make it more difficult to take out a mortgage. Take a look at the black line in the table below. Those points where it plunges are when the federal government tightened housing policy. But neither party talks about it. In fact, the Liberals, Conservatives and the New Democratic Party would all make it easier to take out a mortgage.

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“Giving people more money (more loans) will increase demand and prices,” said Evan Siddall, former head of the Canada Mortgage and Housing Corporation. tweeted September 11th. “It may be good policy, but it is irresponsible policy.”

Waiting for salary

We will know that we are in an inflationary spiral if wages are no longer anchored. Anecdotal evidence leaves no doubt that paychecks are increasing. But it’s unclear whether these increases are problematic. The biggest concern before the COVID-19 crisis was how the workers’ share of gross domestic product had been declining for a long time, so an increase for the working class is likely overdue. Other than that, the data does not send a clear signal. Those who worked through the recession tended to be paid more, making standard year-over-year comparisons unreliable.

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  1. Nothing

    Why the fight against COVID-19 will not end with a high vaccination rate

  2. Excluding fuel, the CPI rose 3.2 percent;  also high, but not alarming like the main figure.

    Inflation is rising at the fastest pace in two decades in a hot streak that complicates the recovery

  3. Liberal Prime Minister Justin Trudeau boards his campaign plane in Halifax on Wednesday.

    Trudeau’s rivals see surging inflation as leverage to oust him

We have tried to correct the effects of the pandemic by monitoring the wages of workers in industries who worked during the shutdowns and comparing their current wages with what they were earning two years earlier. As of June, the most recent data available, there was still little evidence that wages were getting out of hand.

Conclusion: Inflation is a threat, but not yet a current danger.

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In-depth reporting on The Logic’s innovation economy, presented in partnership with the Financial Post.

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