This is the third post in the Price Inflation in Canada series, originally written for my Canadian price inflation explorer & calculator app. The first looked at what inflation is and where it comes from, and the second at why Canadians should care about inflation.

How is inflation measured, and who measures it?

Inflation varies by country and currency. Government statisticians in a particular country usually measure the country’s own inflation.

In Canada, inflation is measured by Statistics Canada. The principal measurement of changes in Canadian consumer prices is known as the Consumer Price Index (CPI). In the United States, the Bureau of Labor Statistics also measures and reports a CPI, although the U.S. CPI measures inflation for prices in U.S. dollars in the U.S. economy.

There are many measures for inflation, but Statistics Canada’s CPI is the one of primary interest to Canadian consumers. Statistics Canada produces the CPI each month by measuring prices for a basket of goods and services. The basket contains quantities of specific goods and services, weighted according to how much consumers buy on average. From time to time, Statistics Canada changes what’s in the basket to reflect evolving consumer needs (e.g. adding mobile phones in the 2000’s.)

Is inflation the same everywhere in Canada?

Prices within a country, and the changes in those prices, do vary from region to region based on local economic factors. Statistics Canada measures inflation for the nation as a whole, as well as for the provinces, territories, and certain metropolitan regions.

Consider the cost of housing: in popular and growing cities, rents and real estate prices can rise faster than in other cities. Similarly, local availability of a product in one region (e.g. fruit, or fish) may result in lower prices than for a region where the product is imported at a cost. Additionally, the pace of economic growth (or lack of it) for a local economy also has an effect on local prices.

Do all prices go up, and at similar rates?

Most prices go up over time, but some product groups have become cheaper. If you’re a buyer of computers or consumer electronics such as digital cameras, you may have noticed these products cost less today than five or ten years ago. Improvements in technology and productivity that outpace average inflation can lead to some items having lower prices than in the past.

Supply and demand also play a role in prices. When demand for a product group increases, the price increases for the product group can outpace inflation. In some cases, changes in regulation play a role (e.g. changes in taxes on tobacco products.) Fluctuating foreign exchange rates are also a factor in the prices for imported and exported products.

The next post looks at what you can do to protect your savings from inflation risk.

This is the second post in the Price Inflation in Canada series, originally written for my Canadian price inflation explorer & calculator app. The first post looked at what inflation is and where it comes from.

Why should Canadians care about inflation?

Inflation causes prices to increase and the purchasing power of any fixed amount of money to decrease. Inflation takes a toll on your income and savings whether you are aware of it or not. Inflation may be gradual, and it’s easy to not notice small percentage changes, but over the long term inflation has a significant and harmful effect on your money’s purchasing power.

Example: Alice has a fixed income of $36,000/year. With that money, Alice buys needed goods and services: food, shelter, clothing, transportation, etc. Ten years on, assuming annual inflation of 2.25%, the same things would cost Alice $45,000, an increase of $9,000! Under inflation, Alice will find it progressively more difficult to make ends meet. Economizing can mitigate some, but Alice will still suffer a significant reduction in lifestyle — even though the dollar amount of her income didn’t drop. It’s better to be aware of inflation and do what you can to maintain your purchasing power.

How can we know there will be inflation in the future?

We can’t know for certain how much future inflation to expect. Yet, we can look to the past for one guess. Over the past 25 years in Canada, inflation’s compound annual growth rate has been about 2.25%. Perhaps future inflation could be similar, if not higher. Inflation varied considerably in the past due to changing economic conditions. Periods of high inflation have happened and remain possible. We can’t know exactly how the future will play out, but expecting and planning for some inflation is more prudent than ignoring it.

One reason future inflation is likely to occur is due to the Bank of Canada’s stated inflation target. Economists and central banks do value some price stability, but it’s generally a higher priority to avoid deflation and its harmful effects. Consequently, the Bank of Canada works to maintain annual inflation within a target range of 1% to 3% (currently).

From the Bank of Canada’s web site: “Inflation-control targeting has been the cornerstone of monetary policy in Canada since its introduction in 1991. At present the target range is 1 to 3 per cent, with the Bank’s monetary policy aimed at keeping inflation at the 2 per cent target midpoint,” and, “One of the most important benefits of a clear inflation target is its role in anchoring expectations of future inflation.” (Source)

So expect some inflation in the future, because the Bank of Canada says so — and because they’re using the tools at their disposal to make it happen. Just how much inflation we’ll see in the future depends on how successfully the Bank of Canada maintains the target range. Managing a nation’s inflation rate is a balancing act with a multitude of factors. Some factors are unpredictable and global in nature and thus not under the Bank of Canada’s control. Commodity price shocks due to a supply disruption could cause sudden spikes in inflation, whereas another financial crisis could be deflationary.

The next post looks at how price inflation is measured in Canada.