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What slow inflation could mean for interest rates

Econ-o-metrics: The Bank of Canada’s critics will say stubbornly low inflation means the latest rate hike was a mistake. But it might just mean the bank waits longer until the next hike.


 
THE CANADIAN PRESS/Michelle Siu

THE CANADIAN PRESS/Michelle Siu

Statistics Canada’s Consumer Price Index rose one per cent in June from a year earlier, as cheaper gasoline allowed Canadians to stretch their paycheques, the agency reported July 21. Alternative measures of inflation that adjust for the more volatile components of the price basket, such as gasoline, were moderately higher than the headline number.

Why it matters:
When the Bank of Canada raised interest rates on July 12, Governor Stephen Poloz said the timing of the next increase will depend on future data. True, the central bank indicated that it would be looking past inflation figures, arguing that the numbers are being skewed currently by idiosyncratic factors. Fine. But the central bank will still be watching prices closely to check that its assumptions are correct. Policy is tied to inflation, so it has no choice.

READ MORE: Why the Bank of Canada hiked interest rates

The trend:
Inflation has been slowing all year, and the June reading matches recent lows from the autumn of 2015. The last time prices were increasing at a slower rate than one per cent was May 2015, when the headline CPI increased only 0.9 per cent.

The modified measures of inflation that policy makers watch to get a clearer sense of the trend are stronger. StatsCan’s core index, which subtracts food and energy prices, was 1.4 per cent, the same as in May. The average of the Bank of Canada’s three preferred inflation measures was 1.4 per cent, slightly faster than the 1.3 per cent average of the previous month.

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Glass half full:
Weak inflation means we have more money to spend—and yes, we’re spending it. Separately, StatsCan reported that retail sales rose 0.6 per cent in May, the third consecutive monthly increase and the latest indicator that Canada’s economy is on a roll. It’s a mystery why that strength isn’t putting more upward pressure on prices. The Bank of Canada thinks inflation is being influenced by weaker energy costs and an odd slowing in the upward trajectory of automobile prices. (Prices of passenger vehicles dropped 0.2 per cent in June, the first decline since February 2015.) Neither of those things should last.

Still, the central bank concedes that changes in the retail industry could have altered inflation dynamics. Consider the spread of e-commerce, which increases competition, but also allows retailers to reach more customers at a lower cost. StatsCan is so new to tracking digital sales that it can’t adjust for seasonality. It’s unadjusted data shows Canadian retail e-commerce increased almost 47 per cent in May from a year earlier. That represents only 2.3 per cent of total retail trade, but growth like that suggests something meaningful is happening in the way goods are bought and sold.

RELATED: What weak inflation means for Canadian consumers

Glass half empty:
In isolation, the inflation data imply that the Bank of Canada made a mistake by raising interest rates. The central bank aims to keep the CPI at the midpoint of a comfort zone that stretches from one per cent to three per cent. Typically, inflation of one per cent signals economic weakness because there is too little demand to force prices higher. The central bank made clear that it thinks current readings of inflation are sending false signals. There will be questions about that judgment until the CPI moves higher.

Bottom line:
The Bank of Canada’s only official mandate is to keep the CPI at two per cent, and it has assured us that inflation is coming. Stronger retail sales bolster that case, although StatsCan noted that if not for automobile sales, retail trade would have been little changed in May. Ultimately, with inflation weak, the Bank of Canada will feel little pressure to raise interest rates quickly. The trip back to a more typical interest-rate setting could be a slow one.


 

What slow inflation could mean for interest rates

  1. Macleans has discovered ‘slow’ inflation. The definition seems to be lot like the kind of inflation the country has had for the past fifteen or twenty years. And what has that done to interest rates? SFA.

    Unless we develop some faster inflation we can expect more of the same. Maybe oil returning to the gold standard or a 10 percent increase in meat prices 9 unless that’s just some marketing hogwash) will get our little red inflation ball bouncing again.

    I remember somebody who enjoyed inflation – he sold balloons.

  2. Inflation targeting spells bad fiscal policy
    http://bilbo.economicoutlook.net/blog/?p=5451

    “The evidence is that while inflation targeting does not generate significant improvements in the real performance of the economy, the ideology that accompanies inflation targeting does damage the real economy because it embraces a bias towards passive fiscal policy which in our view locks in persistently high levels of labour underutilisation.

    Disinflationary monetary policy and tight fiscal policy can bring inflation down and stabilise it but it does so at the expense of creating and maintaining a buffer stock of unemployment. The policy approach is seemingly incapable of achieving both price stability and full employment. I constantly write about these failings.

    An examination of the research literature suggests that inflation targeting has not been effective in achieving its aims. This is despite the constant claims by the proponents to the contrary. Only a minority of the research literature supports the contrary view.

    The most comprehensive and rigorous work on the impact of inflation targeting is the 2003 study by Ball and Sheridan who aimed to measure the effects of inflation targeting on macroeconomic performance in 20 OECD economies, of which seven adopted inflation targeting in the 1990s.

    They used special econometric techniques (which are widely accepted) to compare nations that had adopted targeting to those that had not. Overall, Ball and Sheridan found that inflation targeting does not deliver superior economic outcomes (mean inflation, inflation variability, real output variability, long-term interest rates).”

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    Modern Monetary Theory in Canada

    • Central banks have two jobs: price stability and lender of last resort. The nice thing about inflation targeting is that it completely removes respnosiiblity for economic performance from central banks, leaving them to focus on their mandate, and e one thing ey are good at. Unfortunately, we’ve once again strayed from that single-minded pursuit of monetary stability, with central banks actively trying to goose the economy with easy money policies. The result? Dangerous asset bubbles in housing and financial markets. We saw the consequences of the inevitable implosion of easy money bubbles in 2008, and we have set ourselves up for an even bigger blowout this time.

      And when it happens again, the easy money advocates will blame e few piddling interest rate increases that preceded the implosion. It never occurs to easy money advocates that maybe the problem was created by years of interest rates being too low, as opposed to the half-hearted round of belated tightening that followed. Beleive it or not, some of Greenspan’s critics think his rate increases from 2004 to 2007 caused the 2008 financial crisis. In fact, the seeds for that crisis were sown by his absurdly low rates from 1997 to 2004, when his answer to every economic slowdown from the “Asian contagion” of 1998 to the tech bubble bursting in 2001 was to drastically cut lending rates. Greenspan left a mess not because he tightened too much, but because he loosened too much, then tightened way too late. Central bank’s the world over have repeated the cycle over the past decade, with predictable results. Don’t believe me? Stick around a few years and see what happens after a few more timid, paltry rate increases upset the whole apple cart a second time.

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