Taming inflation won’t bring prices back down

We all suffer from Canada’s inflation, which has dramatically increased the cost of food, housing, fuel and all the other necessities. Everyone hopes the Bank of Canada’s high interest rate policy will soon bring inflation back down to its two per cent target, which will allow a reduction in interest rates.

The Bank has made good progress to that end. In February inflation was 2.8 per cent, down from its recent peak of 8.1 per cent in June 2022. The two per cent target now seems within reach.

But I fear politicians and the media celebrating this achievement (quite prematurely, by the way!) are misleading Canadians that their problems with the high cost of living are about to end. That is not the case. Two per cent inflation is clearly better than eight per cent inflation but even two per cent inflation continues to raise prices and erode purchasing power — just less quickly. The cost of living won’t stop rising unless we get the inflation rate down to zero. And though some prices may actually fall as inflation slows, the average of all prices wouldn’t fall unless we had deflation — “negative inflation.”

Nowadays, however, that hardly ever happens. Since 2002 the increase in the cost of living has been negative only twice — once for the three middle months of 2009, by a combined 2.9 percentage points, when Canada was in the midst of a serious economic downturn, and again for two months early in 2020, by a combined 0.6 percentage points, when the COVID epidemic was rampant. Neither episode had a significant or lasting effect on the rise in the cost of living. Since 2002 food prices have increased by 84 per cent, the cost of shelter by 72 per cent and the average of all consumer goods and services by “only” 57 per cent. Ultimately, these price increases are caused by government policies. In its longterm deal with the minister of finance, first signed in 1991 and renewed every five years since, the Bank of Canada

is committed to holding inflation to two per cent a year. But inflation control isn’t “price control” or “cost of living control.” Had the Bank hit its target every year since 2002, prices would have risen by 52 per cent rather than the 57 per cent they did rise by.

Prices rising by more than half every couple of decades — which means the purchasing power of our money falls by more than half — is hardly price control. We should also ask ourselves whether it’s really good for us. Many economists worry about the downward economic spiral they fear deflation would cause. But with prices rising by half every couple of decades, we are quite some distance from deflation.

How could the government end our financial problems? One possibility would be to pay subsidies to the poor — though subsidies eventually require higher taxes — and to impose price and rent controls. But they would bring only temporary relief and would reduce the long-run growth of the economy. Why? Can you think of a better way to discourage people from producing goods and services, housing included, than to cap the price at which they can sell it?

The only real solution is in policies that increase wages enough to compensate for the high prices. But that requires increases in productivity so employers can afford to pay such wages. (Simply legislating higher wages would be as great a discouragement to production as price and rent controls.) The political problem we face is that only changes to recently adopted policies that are responsible for our recent productivity slump can do the job.

Political opposition to such policies will be great and their implementation will take much time, which means we will have to accept lower living standards for some time to come. How long a time? Your guess is as good as mine.

THE ONLY REAL SOLUTION IS IN POLICIES THAT INCREASE WAGES ENOUGH TO COMPENSATE FOR THE HIGH PRICES.