Why the government can't do much about the Canada-U.S. price gap - Macleans.ca
 

Why the government can’t do much about the Canada-U.S. price gap

It has to do with inflation and the Bank of Canada, writes Mike Moffatt


 

If a recent report from the Globe and Mail is to be believed, the government’s Speech from the Throne today should discuss a variety of measures aimed at lowering the average price of goods for consumers:

The Harper government will pledge action in Wednesday’s Throne Speech aimed at eliminating the gap between the sticker price of consumer goods sold in Canada and the United States, sources say…

“Government, in consultation with consumer groups and the Retail Council of Canada, is actively monitoring the impact of these tariff reductions on retail prices paid by consumers,” Marie Prentice, a spokeswoman for Finance Minister Jim Flaherty, said.

“This is significant, as this will allow the government to assess whether tariff elimination can help narrow the price gap for consumers in Canada, and will help inform future decisions on tariff relief.”

There are many good reasons to reduce tariffs and I am eager to hear what tariff reductions and other consumer policy actions the government will propose. However, if the federal government thinks it currently has the power to reduce average consumer prices to “narrow the price gap,” it will be sorely disappointed.

A small thought experiment explains.

Suppose this slate of policies works better than expected and retail prices fall, on average, by 5%. While a significant amount, it’s still less than the estimated “retail price gap” of 15-20%. Further, this 5% price drop would then be reflected in the Canadian Consumer Price Index (CPI), which contains the “universe of goods and services […] of all consumer goods and services that can be associated with a retail price.” The CPI, like average retail prices, will also drop by approximately 5%.

However, this is the beginning, not the end, of the story. A 5% fall (or more accurately, the deflationary pressures that would cause a 5% fall) in the CPI clearly violates the mandate of the Bank of Canada:

The Bank of Canada aims to keep inflation at the 2 per cent midpoint of an inflation-control target range of 1 to 3 per cent. The inflation target is expressed as the year-over-year increase in the total consumer price index (CPI)—the most relevant measure of the cost of living for most Canadians.

In response to the deflationary pressures on the CPI, the Bank of Canada will be forced to engage in expansionary monetary policy to counteract the 5% price drop (while also ensuring the 2% year-over-year increase in prices continues as planned). This will bring average retail prices back to where they would have been had there been no policy changes.

That does not mean the policy changes were pointless. The Bank of Canada’s intervention caused by the policy changes will affect interest rates, the value of the Canadian dollar, the unemployment rate and a raft of other economic variables. The “pro consumer” policies may change relative prices (some goods will become relatively cheaper, and others more expensive), decrease (or increase) regulatory burdens, increase (or decrease) the competitiveness of border-city retailers with their U.S. counterparts and have a variety of other intended and unintended consequences.

But the one thing the policy changes cannot do is lower overall average retail prices for Canadians, thanks to the Bank of Canada’s mandate.


 

Why the government can’t do much about the Canada-U.S. price gap

  1. Doesn’t the CPI in large part consist of shelter, health care, education, services, etc? A 5% price drop in the type of consumer goods they’re targeting wouldn’t cause near a 5% drop in CPI.

    • Includes some of those, not others. I was using “retail prices” rather broadly.

      But let’s suppose over consumer prices fall by x%, where x is some number that is less than 5. Same logic still applies – the BoC has to counteract that price drop to ensure the overall CPI increased by 2% y-o-y. The overall nominal price the consumer pays for a basket of goods won’t have changed, but the policy “may change relative prices (some goods will become relatively cheaper, and others more expensive)”.

      • Thanks for the reply. So if the prices of goods they’re talking about are 5% “too high” and 1/3 of CPI they might need to create something like a 7.5% drop in those prices which would be offset by a 2.5% overall adjustment by BoC.

        Making the prices of whatever they’re targeting match is at least theoretically possible, albeit with side effects.

  2. Poor argument!
    Not everything is affected by narrowing the price gap between US and Canada. Best example is real estate, which is a large portion of CPI but totally driven by local factors. So the overall impact will be much less than 5%. Also it is a one-time change in prices. CPI is the annul price change. Totally different. You can drop your price baseline once and then continue to have a healthy 2% inflation.

    • 1. See below about the 5% issue.

      2. One time change – 1. Not true because prices are sticky. 2. Even if it were an anticipated one-time change, the Bank still needs to take that into account when setting policy.

    • Believe it or not, real estate prices are not part of the CPI. Mortgage rates, property taxes, rents, housing insurance, maintenance and various other shelter-related costs are part of the CPI, but the actual cost of dwellings is specifically excluded.

      This is how the US managed a massive housing bubble in the early 2000s while the Federal Reserve was still able to say with a straight face that inflation was under control. Canada has pulled off the same stunt more recently. The inflation – in housing – caused by the low interest rates aren’t reflected in the CPI. That doesn’t mean it isn’t inflation.

  3. Good point. The only real way to bridge the gap quickly is for the US dollar to rise vs the Canadian dollar- which would lower the overall purchasing power of Canadians.

    Otherwise, you would need 1% inflation in Canada vs 3% in the US to continue for 7 years in a row while the exchange rate holds steady. With the Federal Reserve on quantitative easing steroids, this is not an entirely unreasonable possibility.

  4. I thought of this very thing. Even if they were successful, the BoC, depending on how “dovish” they were at the time, might decide to lower interest rates to keep the “alarming” drop in inflation from taking hold. Personally, I wish we’d get over our aversion to deflation. Gradual deflation is no more damaging than gradual inflation, and probably a lot less.

  5. So, what response did the BofC take when GST was reduced 2%? Any evidence that the consumer benefited? Or did they just shift spending to a different basket of goods & services?

  6. http://www.parl.gc.ca/content/sen/committee/411/nffn/rep/rep16feb13-e.pdf‎
    While it makes for good conversation, it is OLD news this subject of Canada/U.S pricing.
    The Conservatives are lining up the sheeple of Canada by way of the Throne Speech to show them how great they are at considering the amount we spend out of our sweat. It will make good buckshot for election runs if they can get us to believe they are THE considerate party. The truth is in the above URL. Bottom-line: Nothing can be done! I*f you want to save money, go underground! Pay no sales tax, NO GST, stop consuming by recycling other peoples discards. Kijji, Craigslist, classifieds, local by and sells= NO TAX.