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.
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