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Inflation -- core or imported

Canada is an unusual country, it has since the signing of the Free Trade Agreement changed in ways that make it an oddity within the OECD.  nearly 1/3 of Canada's economy is accounted from the production and export of natural ressources (grain, metals and energy).  

It has made Canada rich when China was in first a development and then credit fed construction boom without precedent.  Look at the New South China Mall or Ordo one of the most well know ghost cities.  Economic growth has now collapsed in China (data doesn't give a scale of the drop in GDP growth) -- Canada being a second derivative country has been suffering a collapse in commodity prices, which include oil.

The Canadian dollar that peaked at 1.06 to the US dollar fell all the way to 0.68 to the US dollar; it has since recovered to 0.76.  But Canada is a cold place and in winter all vegetables are imported from the US -- this year there were apparently cauliflowers being sold for C$12 each.  Now that's real inflation. 

The way the consumer price index is calculated seasonality impact is removed -- after all the $12 may have been high, but in January its bound to be more expensive (on the other hand I have a hard time understanding why anyone would buy cauliflowers in January -- or at anytime for that matter...   Still Inflation that was having a hard time hitting the 2% target has been doing well as of late.

                            Canadian CPI

So the Bank of Canada should be happy, since Canada has had a 2.0/2.5 target for nearly a decade. The fly in the ointment is that a lot of the inflation recently has been driven by fuel prices

                        Fuel Price Chart
            Canadian Dollars price change

The drop in fuel prices (nearly 13% of the past 12 months) is lowering the CPI, but fuel is no Giffen good, and consumption really doesn't change much -- very little price elasticity over the short term -- over the long term the issues change.  So Canadians have been more affected by price changes from other sources (such as vegetables) than the CPI shows.

For the BoC the issue is what do to with interest rates!  Really its the only real policy tool.  Like the Feds south of the border, the BoC has been trying to raise interest rates for some years now, with little success.  Every 25/50 bps changes in the prime rate has been beaten down by sudden economic slow down.  There is no doubt that the Canadian establishment didn't want to raise interest when the economy was booming because the CAD dollar was already so strong, they didn't want to encourage more hot money.  Still it was probably a policy mistake; possibly adding some form of short term (not market friendly) barriers to buying GoC securities to dampen the F/X game would have helped and have allowed the BoC to raise interest rates, but the idea of introducing market distortions was contrary to the spirit of free trade embraced by Canada.

Now Canada is without effective policy tools -- taxation is fully spoken for, the Government of Canada has been spending like crazy -- a C$ 22 billion deficit was recently announced, and interest rates are stuck in low gear at 0.5%...

Canada's central bank, like all OECD central banks is out of classical economic tools (not to sure that they worked that great in the past), and has few options.  The BoC has been neutered.  

  



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