Wednesday, August 27, 2008

Inflation worries

In the new issue of Macleans, there is an article about the global swing towards higher rates of inflation, and how it is affecting Canada. The Bank of Canada has an official target rate of between one and three percent, and for the most part, it's done well to maintain that over the past few years. But the last report, which I posted on here, gave reason for worry. And according to the article, the Bank admits we'll be at 4.3% by the start of next year.

One caveat: this is the official consumer price index, but the core rate, which excludes volatile commodities like gas and food, is more stable. Of course the question becomes "how long", since neither gas or food prices are expected to go down much any time soon.

So what's the problem? A lot of it is beyond our control. Inflation is creeping up all around the globe, in some cases, disastrously so (a million dollar note in Zimbabwe is used as toilet paper). And the growth in commodities prices is really quite unprecedented.

(Photo: AFP/File/Desmond Kwande)

Normally, the answer to inflation is simply to raise interest rates to slow down the economy and hope you nip it before it gets out of control. But in our case, it's really a tale of two economies. On the one hand, you have the red-hot western economy, fueled by Alberta's oil boom. Growth is strong, but so is growth in prices. This is referred to as "demand-pull" inflation, as the increased demand is literally pulling prices upwards. But on the other hand, you have Ontario, whose manufacturing sector has been shellshocked by the strong Canadian dollar and weak US economy, both of which combine to drive down the demand for exports, particularly automobiles. Inflation in Ontario is actually quite low.

The problem here is that the central Bank sets monetary policy for the entire country. Since we all share the same currency, Alberta cannot have one monetary policy and Ontario another. What we are seeing is a remarkable divergence in economic fortunes in different parts of Canada, and whatever happens, no one is likely to end up happy.

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