The new year topic du jour for the Canadian economy is disinflation; media economists and other experts are now warning that interest rates have been too low for too long.
Some say this year there will be a lot of discussion of the fear of disinflation in Canada. But what does this mean for everyday Canadians? How does this affect our cost of living… and should we be worried? To understand disinflation it’s important to know the role inflation plays in the health of the economy.
What Is Inflation?
Inflation is a general increase in the overall price level of the goods and services in the economy. The Bank of Canada measures inflation by using The Consumer Price Index (CPI). This is an indicator of changes in consumer prices experienced by Canadians. It is obtained by comparing, over time, the cost of a fixed basket of goods and services purchased by consumers. This includes food and energy. So, for example, if last year you paid $1.00 for a loaf of bread and the rate of inflation this year was two per cent, that that same loaf of bread would be $1.02 now. This increase in cost is also supposed to be balanced with an increase in salary and return on investments. But since 2008 this has not been the case for the Canadian economy, and this has economists worried.
Disinflation Vs. Inflation
According to the Bank of Canada, disinflation is a slowing in the rate of increase in the general price level, as represented by the average price of goods and services in the consumer basket. Deflation, on the other hand, refers to a persistent fall in the level of the total CPI, with negative inflation being recorded year after year. The one major episode of sustained deflation in Canada was during the Great Depression of the 1930s, when the overall level of prices fell by more than 20 per cent over a four-year period
Normal Inflationary Times
The Bank of Canada aims to keep inflation at around two per cent. So year over year the cost of goods and services can rise by that much. For example a basket of goods in 1914 that cost $100 would cost us $2016.39 today. Try the Bank of Canada inflation calculator to see how inflation works over time.
Economic Growth Needs To Pick Up
In November, Statistics Canada reported that the inflation rate in Canada was 0.9 per cent – a rise from 0.7 per cent in October, but still well below what is considered normal. In a recent interview Bank of Canada Governor Stephen Poloz said his target rate, which is closer to two per cent, will make it easier for businesses to make investment decisions and for wages to rise. For Canada to get back to normal economic times, inflation must pick up the slack.
How Inflation Affects The Bank of Canada
Poloz has to make a decision about interest rates this year. If he raises rates, the cost of all goods and services will go up for everyday Canadians and inflation therefore will increase. But that also means it will be more expensive to borrow money and this will impact business activity. He is in a difficult position as Canada’s economy is slowly improving because rates are low but inflation has slowed.
What Can Canadians Do To Counter Disinflation?
If interest rates were to rise and inflation was to normalize, there would be an increase in the cost of living. But it could also lead to lower prices in some segments. For example, the cost of buying a home could lower as a result of rising mortgage rates, which would push some buyers out of the market. Such decreased demand could in turn soften seller prices.
Its most important to focus on playing off any high interest debt right now as higher rates and more normal inflation will make that loan harder to tackle in the future. This will continue to be a major topic of discussion in 2014.