The Canadian economy got a bucket of ice water poured on it in June. Statistics Canada numbers show that the Consumer Price Index (CPI), one of the primary measures of inflation, has fallen to a multi-month low. This massive drop in the CPI may indicate that the economy is rapidly cooling.
CPI Falls To A 20 Month Low
CPI fell to a multi-month low, bringing huge questions about the health of the economy. The 12 month change in June came in at 1%. This is better than negative, but is far from the 2.1% we were looking at in January 2017. CPI decelerating at such a rapid rate brings up concerns of deflation. Deflation is arguably worse than high home prices, and generally only occurs during a severe recession.
Source: Statistics Canada.
Uh…What’s It Suppose To Be?
The Bank of Canada tries to maintain a target rate of inflation, to control a consistent supply of money. The target rate is 2%, although we’ve rarely hit that number in the past 5 years. The 5 year average has been 1.35%, when measured as a 12 month change. The median 12 month change is 1.3%. If the rate is too low, the economy is generally not doing so hot. If the rate is too high, the economy is overheating. If inflation is growing at half of the intended target, it’s tough to argue the economy is firing on all cylinders.
Uncharted Waters For Canada’s Central Bank
Normally the BoC has an easy gig, using pretty standard moves to control the money supply. When CPI gets too high, they raise rates to cool borrowing. When CPI is too low, they lowers rates to stimulate borrowing. Unfortunately, they’ve decided to play politics this year.
The BoC’s sole purpose is to control the money supply, and watch the target rate of CPI. Unfortunately, they raised rates while the economy was experiencing deceleration of CPI. Raising the cost of borrowing when inflation is tapering, could send that number into deflation. Deflation isn’t something developed countries generally experience. Once deflation hits it’s hard to prevent a deflationary spiral. That’s when the cost of goods lowers, which reduces production, leading to less employed people. Less employed people, leads to less consumption of goods, and it continues… you know, in a spiral.
Home prices needed to be cooled, but should have been done with legislative measures – not monetary. If all branches of government are watching home prices, who’s watching the flow of the money that should be fueling business growth? Afterall, lowering interest rates raises price. However, raising rates has historically had a minimal impact on cooling home prices.
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Wages are suppressed to sh*t and then people wonder why there is no inflation. Millions of Canadians out of work, 320k new migrants every year, unlimited Temporary Foreign Workers, no jobs for any of this madness. Youth completely screwed, part time, temp, contract work galore. Labour market flooded to sh*t. This country is in dire straits. Meanwhile in the US they’re hitting their target 2% inflation because 4.4% unemployment, tightening labour market, wages rising, and illegals getting btfo deported as it should be.
What are you blathering on about? Go to bed son, you’re drunk.
The CPI is not all that it is cut out to be. It only measures a select basket of goods. It is supposed to be balanced towards the middle income group, but therein is the conundrum. For anyone making over, say, $150,000, the CPI is meaningless. Their basket of goods is very different than the middle class. When you have excess disposable income, you invest it, you do not spend it. The CPI only effects the part of one’s income that is used for consumption.
Even income directed to savings is unaffected by the CPI.
But I have oft said that the CPI, the prime rate, productivity increases, wage rate increases, and the GDP growth rate all have to be evaluated together. Looking at one in isolation just doesn’t give a good picture. If the GDP growth rate is out of proportion to the CPI, then something is broken. If the GDP growth rate is within bounds of the CPI, mediated by the interest rate, wage increases, and productivity gains, then the economy is growing at a stable, sustainable rate, albeit today, a slow rate.
In fact, I argue that the interest rate directly drives the CPI, it is not inversely driven. That is, as the interest rate goes up, things cost more (interest paid is a cost NOT considered in the CPI, but a very real cost), and therefore the CPI should go up. This is especially true in an economy that runs on credit purchases.
Consider if mortgage rates go up, the average homeowner with a mortgage will be spending more of their income, but purchasing less. Even with a null CPI increase, this consumer will have less disposable income to spend. But if the interest rate is calculated into the CPI as a legitimate cost, then the end effect on income and spending will better match reality. However, the existing economic theories will be blown to heck.
Most economic theories are driven by the concept that ‘demand’ drives everything. However, in an economy that is driven by middle-class investment, money in excess of what is used to purchase goods is used for investment, and has no effect on prices. In other words, there is a saturation point for demand, and once this limit is reached, the economy is driven by other factors (greed? The profit motive – the search for the highest return on savings and investment?). If there was a major flaw in Keynesian economics, it is that he ignored the diversion of money from the economy into financial investment products instead of consumption. (‘If I have more money to spend, maybe I will invest it rather than spend it.’ Ironically, the more money sunk into the stock market meant that overall demand went down. And money put into the stock market is dead money – it actually reduces the capital monetary supply. Not one penny of the money invested in buying existing stock goes towards capital – towards financing new plant and infrastructure. It goes into someone’s pocket.)
Unfortunately, the stats for money used for non-consumer-spending (‘savings’) are greatly skewed, because money that is invested is not considered money put into savings. It is assumed that if Canadians are not saving it, they must be spending it. It is completely ignored that they might be investing it. Thus, while it looks like Canadians are not saving for retirement, this completely ignores the money they have in investments (income properties?) for retirement. When the interest rate on savings is low, upper-middle-class Canadians look for other means of gaining a higher rate of return, in non-savings instruments (like houses and income properties).
The CPI in isolation ALSO does not consider that prices may genuinely be going lower because of increases in productivity. Although the CPI is somewhat controlled for technological developments, it is not exact. Alternatives to the iPhone, for example, that are much cheaper but deliver the same or better utility, drive the price of the iPhone lower (on two year plans) so overall prices go down without affecting overall consumption. WalMart is notorious for pushing prices lower, as competition from dollar stores heats up. Thus, it is entirely feasible that with a null CPI increase, overall consumption and thus employment could be increasing.
However, if price increases are driven by investment in automation and the neoliberal quest to maximize profits, then a very high CPI increase could be commiserate with widespread job losses and higher unemployment.
For these and many other reasons, the CPI alone is not really useful for making future predictions.
You know your shit! Great comment! Thank you!
Borrowing costs are in fact included in the CPI. Mortgage rates are included along with rents to represent the shelter component. What’s missing from the CPI? The price of housing. The CPI would be showing a much higher number right now, and that would have been true for years, if the price of housing was included in the shelter component. And house price inflation is just as real as inflation showing up anywhere else, and central banks need to act to contain it.
No way do interest rate increases create more inflationary pressures. That’s just completely wrong. Increasing interest rates restricts credit growth, which reduces demand, which reduces price pressures, and therefore inflation.
I’ve seen inflation brought down twice in my lifetime via restrictive monetary policies (i.e. high interest rates), first in the early 80s, and again in the early 90s. Both times it was a painful process, and the recessions took years to recover from, but there was no other way of doing it. Interestingly, both of these tightening cycles were embarked upon when the economy and the labour market was already weak. For those who think central banks can’t increase interest rates because the economy is too weak, I can tell you that never stopped them before.
What is so crazy is the over analysis of everything! Statistics are an art form and you can make them say anything you like and trying to create a theory about a short term period is truly meaningless.
I do agree however that the financial health of Canada truly is really in bad shape. But no one is looking at the real problem that Canadians face, which is the root cause of the mess for individuals and businesses alike . We are severely overtaxed here…federal and provincial income tax, HST consumption tax, plus all the additional indirect taxes on goods and services. This incredible increasing tax creep needs to be stopped. Most people do not have any meaningful discretionary income anymore. Dollar stores, Walmart and Thrift stores are doing a booming business. I never thought in my life that I would ever cross the thresholds of these types of places…but I do now. And obviously I am not alone.
> What is so crazy is the over analysis of everything!
You’re reading a blog on economic analysis and housing trends. You understand that, right?
The problem with this country is for too long people, especially real estate agents, treated assets like impulse buys. Assets are things that need to be evaluated before an acquisition, not something you go “it always goes up!” All things that impact capital flows will impact the pricing of assets, homes included.
There’s a reason Mainland Chinese investors are cleaning up in real estate – they have agents with fancy business degrees that can explain every aspect of each home to their investors. That why the good agents average 3-4 sales a year to their (local) Chinese buyers.
No, borrowing costs are NOT reflected in the CPI.
If I purchase a new car, and finance it over 5 years at 0%, or I finance it at 10% over three years, the initial cost of the car remains the same, even though my payments are very different, and the net final cost is considerably different. This hidden financing cost is not in the CPI.
If I finance a mortgage at 1% for one year, or 1.5% over five years, my exposure to interest rate increases is very different. The CPI basket of goods only weights mortgage interest at 4 points out of 100. Meaningless for people without a mortgage, woefully inadequate for those with a mortgage. If mortgage rates do go up by 1% or 2%, the CPI will be way off for them.
My assertion stands – CPI does not adequately reflect interest rate changes and the effects on consumer spending. If it did, then interest rate increases would trigger a substantial corresponding increase in the CPI, but it won’t. The CPI is only meaningful when it is considered along with interest rates.
http://inflationcalculator.ca/cpi-basket/
There is NO direct evidence that the high interest rates had ANYTHING to do with bringing inflation rates down, and EVERY evidence that higher interest rates drove inflation higher. During the two periods you mentioned, every time the interest rate was raised, inflation went UP, not DOWN. Inflation was beaten by other factors (the easing of the baby boom demand as the boomers becoming adults ran out of buying steam, and demand dropped) not interest rates. In fact, the faster interest rates dropped, the faster the fall in inflation. Economists would say that the inflation rate drop was caused by increasing interest rates, but the timing indicates exactly the opposite relation. Economists put this down to the ‘lag effect’, and miss the real relationship. Without the high rates, the recession would have been far less painful, but would still have occurred as boomers stopped buying.
However, these high interest rates had a more enduring destructive force besides high inflation. It led people to believe they were entitled to high interest rates of return of ten percent or more, that these rates were normal, and should be expected. As we return to more historically normal rates of a return of under 5%, it is leading to widespread anger and of people feeling cheated. The Trump phenomena was entirely predictable, and had its roots in these high interest rates that could never be sustained. Yet the American public still demands them, and blames their politicians for what was inevitable – regression towards the mean, the re-establishment of normal rates.
But you will never get a traditional Friedman economist to accept that.
Borrowing costs have no business in the index at all. The CPi is supposed to measure inflation., not borrowing costs. Putting borrowing costs in the CPI in any form introduces an automatic pro-inflationary bias into the index, by making inflation seem lower than it is just because borrowing costs have fallen. If you think the cost of money itself should be included in the indices we rely on to monitor the purchasing power of money, then you don’t really understand what inflation is.
There is NO direct evidence that the high interest rates had ANYTHING to do with bringing inflation rates down, and EVERY evidence that higher interest rates drove inflation higher. During the two periods you mentioned, every time the interest rate was raised, inflation went UP, not DOWN. Inflation was beaten by other factors (the easing of the baby boom demand as the boomers becoming adults ran out of buying steam, and demand dropped) not interest rates. In fact, the faster interest rates dropped, the faster the fall in inflation.
Interest rates dropped after inflation dropped. Not before. This isn’t even a debatable point. It’s recorded history. Interest rates were eased only after inflationary pressures were eased. The converse is also true. When Greenspan dropped the Fed Funds Rate by 2% after the stock market crash in 1987, did inflation go up or down over the next two years? When Greenspan recklessly dropped the Fed Funds Rate to 1% in 2003, did housing prices go up or down in the US? When the BoC dropped rates during the financial crisis, then kept them low, did housing go up or down over the next few years? When Poloz dropped rates twice in 2015 in a panic over low oil prices, did housing go up or down in price? Every time rates dropped, inflation took off. Increasing house prices are just another form of inflation – inflation that is totally missed by our inadequate inflation indices, both here and in the US. And increased house prices are a product of low interest rates.
Next you’re going to tell me that houses are assets and not consumer goods, so they shouldn’t count in the index. Don’t bother. I heard the argument 25 years ago, and it’s just as wrong now as it was then. It is precisely that flawed logic that has created the mess we are in now. In fact, inflation has been rampant these past few years, but it’s all flowed into housing, so it hasn’t moved the CPI at all. That’s why we get articles like this one, telling us inflation is too low to raise rates.
Please observe the following charts. Clearly, when interest rates went up, inflation went up. Check out the 1980 period – the higher interest rates went, the higher inflation went. As SOON as interest rates started coming down in 1980, inflation came down. But then, even while inflation was coming down, they raised interest rates back up. In 1985, interest rates came down, and inflation clearly followed the drop.
And in the 1971-72 period, inflation was about three percent and falling – but they STILL raised interest rates, and inflation went up.
I remember being in union negotiations at the time. Interest rates skyrocketed, and wage demands followed suit. Employees NEEDED higher wages to offset the higher mortgage costs. Mortgage interest certainly did not go up AFTER the employees got a wage increase. When employees got huge wage increases, this drove prices up.
Use common sense – union wage demands go up when interest rates go up. Recent wage demands have been moderated because mortgage payments have come DOWN with low interest, and are STAYING down. Although wages are relatively stable, middle class homeowners who have re-negotiated mortgages at rock-bottom interest have a lot more money in their pocket.
Use common sense, not over-hyped economic theory that was absolutely useless during stagflation and recently, in the last five years, when low interest just didn’t stimulate the economy. Nothing wrong with the economy during stagflation, it is the theory that is all messed up. Unless, of course the ‘theory’ was just to convince the poor man in the street that higher interest rates were needed to fight inflation.
The ONLY reason for these high interest rates was NOT to bring inflation down, but to increase financial returns to outrageous levels.
https://www.economics.utoronto.ca/jfloyd/modules/evin.html
Please site your sources that ‘clearly’ show your contention that you are so ABSOLUTELY sure of.
Those charts show nominal interest rates. Real rates – the difference between the interest rate and the inflation rate – show an entirely different story. It’s true that interest rates chased inflation higher throughout the 70s, but “chased” is the operative word. Central banks remained well behind the curve until the early 80s.
Also not shown – nor mentioned – on your charts is the lag effect of monetary policy, which can be 12 months or more. So if interest rates are raised to head off inflation, inflation can continue to accelerate for a time after rates are raised, making it look, to those who don’t know very much, that interest rates caused the inflation.
My mistake, he does show real rates in the right hand graphs. Which just prove my point. Inflation took off in the 1970s, right when the real interest rate was negative. Rates had to go strongly positive for years afterword to bring inflationary pressures back down.
The fear of deflation is largely overstated, bordering on irrational. Gentle YoY deflation is possible without turning into a deflationary spiral. In fact, there is no reason why you can’t have 2% deflation while still having a growing economy. We just never see it because inflation expectations are always there. 2% deflation is no more likely to become a deflationary spiral than 2% inflation is to become an inflationary inferno.
Deflationary times are generally tough times, but not because of the deflation itself (unless it becomes a deflationary collapse due to a shut down of the credit markets, in which case deflation definitely feeds on itself in an implosion of prices, value and incomes). Generally, in such cases, the deflation is just a symptom of a sick economy. However, structural deflation created by increases in efficiency, productivity, and innovation is certainly possible, and in such a case, mild deflation is be no impediment to growth.
“The fear of deflation is largely overstated, bordering on irrational.”
The last time deflation occurred, we were in a recession and interest rates had to be aggressively cut to prevent a a deflationary spiral. When rates are this low, the only other thing we can possibly do is institute quantitative ease. While the analysis is simplistic in its approach, I 100% agree.
If the BOC decides to do quantitative ease, we’ll have a much bigger problem with our currency going to crap.
Or we can just accept some deflation. Japan has been “fighting deflation” for 27 years now. How’s that worked out for them?
Case in point
interest rates 2%
non-adjusted GDP increase 2%
wage increase 2%
productivity increase is 4%
then a CPI deflation of -2% completely balances the equation, and is entirely due to the left-over productivity increase after 2% wages are factored in.
2% of productivity increase cancels 2% wage increase
Interest rate (investment money) and productivity increase accounts for the GDP increase with a negative CPI increase (typically one expects the unadjusted GDP to mirror the CPI increase, all other things – especially productivity – zeroed out).
However, this is entirely hypothetical, because greed will drive the financial community to take the extra 2% in profit, rather than price decreases. Thus, return-on-investment will greatly exceed the 2% interest rate.
When interest rates, inflation, and wage demands finally were wrestled to the ground, absolutely no business LOWERED their prices just because their interest costs decreased. It all went into increased profit.
That factor is why the CPI is practically useless on it’s own. It completely discounts the effect that expected rate of PROFIT has as the primary driver of prices, NOT input, interest, demand and supply, or wage costs. However, rate-of-return, or profit, rate is driven in part by expected interest rate returns – the higher the interest rate, the higher the profit expected.
Incidentally, that is exactly why higher interest rates lead to inflation, because the higher the interest rate, the greater the profit needed and expected to counter it, the higher that prices have to move in order to generate this profit. If you can make a greater return by puting your money in the bank than selling product, why sell product?