Panelists:

Amy Peng (Toronto Metropolitan University)

Mario Seccareccia (University of Ottawa)

Luis Seco (University of Toronto)

Moderator: 

Louis-Philippe Rochon (Laurentian University)

 

Q: Let's start with a simple question. How is inflation calculated? 

Amy Peng: Inflation is actually a very simple formula: It measures the annual rate of change in the price index of usually a fixed-market basket of goods that we usually consume. The most commonly used index is called a consumer price index. It represents changing prices in a Canadian setting as they would be experienced by Canadian consumers. It measures price change by comparing through time the cost of a fixed basket of goods and services. Here in Canada that basket is divided into eight categories, including food, shelter, household operations, furnishing equipment, clothes, footwear, recreational, transportation, education, cost, alcoholic beverage, tobacco cannabis, and all of those things combined make over 300 items.

I also want to emphasize that this type of index is actually a weighted average, so we calculate a weighted average of all of the items listed. The question that usually comes through is how the weight gets determined and it’s usually determined or adjusted based on spending pattern changes over the years. In the last few months, stats have updated the weight again and it’s usually based on some type of survey, like a household financial consumption expenditure survey or survey of household spending. When inflation is 7.7%, that means the consumer price index has changed or increased by 7.7% compared with the same time last year, which is May 2021.

 

Q: This inflation is being driven by a very small number of items like gas, rent, et cetera. What are the mathematics behind this current influx? 

Mario Seccareccia: I'll just give you two categories. For the last month here in Canada, clothing and footwear went up by 2.2%, while gasoline went up by 48% over the year, just so you get a good idea of how different the rates are. In fact, there might even be prices falling, believe it or not, but it would be such a minor component. For sure there are prices that are barely rising or are within the 2% range that the Bank of Canada would like to see growth at, but other categories are rising big time. The big one is the oil prices, which literally takes us back to the 1970s and early 1980s when these oil prices were following a similar pattern to now.

AP: It’s very true. Across those items, there's great deal of variation. We know the crude oil price has increased significantly due to the Ukraine war. Last time I checked it was $110 per barrel. Just putting perspective on growth, this is 12% in this month alone. Compare that from March to April, where it actually declined 0.7%, but then from April to May was a 12% increase. That really captures why there is significant impact, because crude oil and gasoline prices impact a variety of items in the fixed basket.

Luis Seco: In 2008, when the financial crisis hit, interest rates became negative. The fear back then was that inflation was going to jump up immediately. It didn't. In fact, it was not only below targets, inflation was actually considered to be too low for a lot of the spending that was done to get out of the 2008 crisis. Now, so we're at 7.7%. Essentially, what we wanted to happen 14 years ago is happening now. The second thing is 7.7% is a high number, but what's even higher is the rate of change. Inflation was very low just a few months ago. How fast it came up is I think, in my opinion, something which is... I'm not going to scare anybody. This is not about scaring. We just want to understand the numbers. What do the numbers say? What I think is remarkable in this case is how fast it has grown over the last few weeks.

 

Q: Robert Reich from the Economic Policy Institute in the US, and David McDonald, here the Canadian Center for Policy Alternatives, have both touched on profit inflation. That’s when corporations profit from the confusion, raising prices in order to make higher profits. Does anyone have anything to say? 

MS: The fact is there's a big debate going on right now. In the US, a study done by the Roosevelt Institute just a week ago looked at this kind of markup inflation, which could be an opportunistic attempt to take advantage of the confusion going on. You're going to see your grocery store, or whatever, raising prices even though they're not facing higher costs. It's very important to take note that the inflation was 7.7%, meaning the consumer price index went up by 7.7% during April and May. The wages in Canada were growing at less than 4%.

So, what's going on here is that wages are starting to creep up a bit, but most of what is actually going on has nothing to do with wages. Yes, in the case of transport cost, it’s obvious if you see a skyrocketing gasoline price, but there are a lot of other prices that are less clear as to where they’re coming from. There have been a lot of studies on that over the last year trying to show that if you look at 2021 in terms of corporate profits, those profits skyrocketed. But also, if you look at in terms of the price cost ratios, unit cost ratios, they are widening. That is a fairly ubiquitous kind of phenomenon, in the United States, at least from the studies that I've looked at right now. 

 

Q: There was a time when even the Bank of Canada was saying that inflation was temporary, and it turns out not to be the case. On top of that, the Bank of Canada raised rates three times; the Fed as well. Why is inflation not temporary and why does it keep going up? 

AP: If you open Bank of Canada's website, the first thing they say is the main objective of the monetary policy is to preserve the value of money by keeping inflation low and stable. The central bank only has one instrument here, and that is the policy interest rate, which is a form of short-term interest rate. When one key policy interest rate changes, all interest rates in our economy get affected, and all consequently make their adjustments. Our prime rate has gone up to 3.7%. Our five-year fixed mortgage rate has gone up to about 4.6%. We're expecting another 75 basis point increases in July, which a lot of forecasting expects the mortgage rate or fixed rate to go up to 5%.

For the monetary policy to work, it relies on a transmission mechanism. This is something we teach our first-year economics students. It explains how interest rates affect our decisions on saving and spending. As interest rates increase, the opportunity costs of money also increase. Expecting all of us, if we are rational beings, to then behave rationally, means we should save more and spend less because costs are going up, but there are factors affecting the transmission mechanism: Number one is that inflation can become entrenching in a way when it fits itself. Price rises because other prices are rising and labour compensations may go up. They actually have gone up last year a little bit. The Bank of Canada also claims there is a policy lag of six-to-eight quarters, which means from the policy rate changes, two are full-impact on the economy. It's going to take six to eight quarters, so even though we're changing the rate now, we're not going to see the full impact until next year. That's pretty much what they claim. The last one is will people behave rationally, cutting their spending and saving more as interest rate goes up?

In addition, we know when the economy comes out of a lockdown, there are many types of restrictions everywhere on the whole in Canada, Everywhere is just starting to recover a little bit, in addition to the strong performance of the labour market. We saw the unemployment rate is around 5.6% in Ontario, and around 5% nationwide. We're expecting the demand side for goods and services may continue to grow. Not everybody has a really tight credit constraint, which means when people want to spend money, they can actually borrow as well, which explains why last year, even in a pandemic-induced recession, we still have a relatively hot housing market.

 

Q: What's driving inflation right now are these demand-sensitive products. So, raising interest rates by 75 basis points won't solve the war in Ukraine; they won't solve the supply chain bottlenecks. From where I'm standing, monetary policy in this very moment is probably ineffective and the banks are probably raising interest rates in order to save face. I know that they've been criticized a lot for being slow on the trigger. I wonder if Mario or Luis have any comments on that?

MS: You're absolutely right that in an environment where it's basically a supply-side kind of effect here of price changes, raising interest rates will not do very much. What they're trying to do, though, and where it is a problem, is that it will not have much impact on the inflation rate, which is primarily internationally determined. Housing prices are a good example, but when it comes to oil prices, for instance, we know perfectly well that it is not going to happen no matter what Canada does in terms of raising interest rates. However, what they're trying to do is something else, which is that it will create unemployment problems. At least you'll create a more recessionary kind of environment in place, and by doing so, what you want to do is stop wage growth from trying to catch up with this inflation. 

Now is this the right way of doing things? I'm one of those who have preached over the years that you don't want to raise the income of one group here because interest is not just a cost; it's also an income for certain people. You're raising the income of one group in order to kind of compress or control the income growth of another group. To me, that is a terribly bad way of dealing with a problem which should be dealt with differently. In this case, I would call for a more cooperative kind of arrangement rather than through a more adversarial way of dealing with it.

LS: This is a worldwide effect, so whatever you do in a country, especially a tiny country like Canada, is probably not going to have very much of an impact. The other thing is, as Mario was saying, increasing rates may create another dynamic that has nothing to do with the cost of the inflation and create another one that may counteract it. But again, the inflation number is a very simple number that in no way tells us what's really happening with all of the variables that go into it. So if we care about inflation, there's a room for other types of measures. Monetary policy hasn't been effective in the last 14 years. I don't think it's going to be effective going forward.

 

Q: Economists distinguish between a discontinuous jump in prices and a continued or sustained percentage change in prices. The first one is not considered inflation while the second one is considered inflation. Can you comment on that?

MS: Well, it's obvious that if you buy a sack of potatoes that has gone up from $1 to $2, then what we see here is a discontinuous jump, if you want to call it that in the price of that product, and that's final. I mean, that happens all the time. We have these ups and downs in a dynamic setting, but that is not an inflation. What becomes an inflation is two things: One, it's fairly broad-based. It's not just going to be potatoes here; it's going to be a lot of commodities and prices going up. Secondly, of course it tends to be continuous.

In terms of the language of math, it's like a discrete change versus a continuous kind of change. When it's sustained and it's continuous over time, for those of you that have studied calculus, a differential equation type of modelling, that tends to be what we mean by inflation. All the language of economists normally, when it comes to macroeconomic issues, has to do with inflation and not just a price-level change. So, in that sense, that's important.

 

Q: We're seeing numbers like in 1983, which was another period of high inflation on the heels of the oil crisis in 1979. We have high oil prices today as well. But is inflation the same as in the 1980s?

LS: So many things are different now than they were before. I'll start with the impact of oil. The oil crisis of the 70s did have a spillover effect. It took four years or so for that to happen. Here, it’s taking four months. We're not even at the point of the oil embargo, so that analogy already doesn't work. Second, the world in 1983 was not as interconnected as it is now. We were in a very interconnected world, relying on supply chains that were very efficient. Now they're all broken down. I don't think, looking at what happened in 1983 is going to help us in any way. 

Number two, is there may be two things moving in parallel. So, what are we worried about? Are we worried about inflation being 7.7% or are we worried about the increase in interest rates that makes all of us fear mortgages going up or home prices going down? These are different things. Maybe both are bad. Maybe we worry about both sides of that equation. I'm no politician; I'm a mathematician. I study numbers. I study formulas. I study graphs. We need to understand exactly what's the cause of that and resolve the problems which are there and not that just one number.

 

Q: There's a comment or question here by Kumar. He says that the indicators we are talking about were defined a long time ago and are quite coarse. Would you suggest alternative more modern quantitative indicators to understand the dynamics of economic change?

LS: I'll say one comment. If you fly an airplane with the models that are used to calculate inflation, that plane would not even take off the ground. 

AP: But at the same time, the simple number normally is what people rely on. Whenever we talk about the state of the economy, we talk about real GDP growth, unemployment, inflation. Assuming those are the numbers we are reporting a monthly or quarterly basis, those are the number people can understand. I understand there's a reason to change them or change the underlying model, but we still need the simple numbers in order to actually inform the public.

LS: I agree, but look at weather forecast, right. Imagine weather forecast without the windshield factor. That means nothing, right.

MS: The CPI encapsulates a specific group of items that are good or bad. You cannot criticize what is a definition. But as everybody knows in actual fact, not only do we look at various categories of the CPI, but they’re used to produce effects for different income-level groups. For instance, if you're in the $30,000/year or below category of income today, what you buy is not the same as what is included in that CPI. It doesn't pertain to you very much, except for certain food products or rent or whatever. Somebody who's earning $150,000/year, he or she might be more interested in the housing prices or something to speculate on even. But we don't do that. We just encapsulate everything into that CPI. We have policy framed – monetary in this case – on the basis of that particular CPI change, which could be useful for certain purposes, but it may not be useful for other purposes. To put everything in one basket and call that CPI might be problematic. So I don't disagree with Kumar. When you raise this problem, there are possible indicators that might be more appropriate for different people. It's not good for all seasons. 

 

Q: We started with a simple question; we're going to end with a difficult one. When is inflation going to come down in Canada?

MS: Well, can we predict when the war in Ukraine will end? Or will it end, as the President suggested, by the end of the year before winter? God knows. I mean, it's hard to predict any of this stuff because a lot of it is tied to all these changes going on in the world economy right now, the tremendous dislocations, supply chain problems. For instance, furniture that we import from Asia, we’re having a lot of problems getting that over here and that is a supply chain problem nobody predicted a year ago. Okay. But how could we know certain things? I would be willing to bet that by next year that supply chain problem might [not be] about furniture, but about the war. 

LS: I would say that I can only predict one thing, which is whatever prediction I give would be wrong.

Louis-Philippe Rochon: The last word to Amy.

AP: We live in so much uncertainty. So one thing I know is rapid price changes create uncertainty. We rely on government, the Bank of Canada, the central bank to make decisions. But then what if the decision is wrong? We don't really know until it unravels in the future. Right now, it's very difficult to see which direction it’s going go. Only thing we know is it's caused a lot of speculation. Mario talked about asset pricing. There's the housing market. Anything related to capital movement and financial market investment is really uncertain out there. We can hope for the best. I hope the war ends soon. If we have a crystal ball, if we can make a one wish, that's what I would wish for, the war to end.

LPR: Well, let me finish. You mentioned uncertainty and I asked about when will inflation come down. Let me finish with the quote by Keynes: “We simply do not know”.