Tuesday, April 15, 2014

Still no $%& inflation

The Bank of Canada has a thing for inflation.  For years the BoC has had a 1.5% to 2.5% inflation target.  A necessary lubricant to a growing economy, and yet prices are just not cooperating.  Inflation has been rising recently to near the lower target of 1.5%, but every time we get close inflation disappears again.

(Source:  Statistics Canada)

The CPI is a measure (warts and all) of the consumer costs, another is the Industrial Production and Raw Material which also shows limited movement (at least until early 2004)

The problem that virtually all that price increase was caused by energy costs that have soared following the "continuing disagreements" in the Ukraine.  Bottom line oil prices rose from around $90/bbl to $106/bbl -- a 17% increase in 4 months.  So really no help there because everything else is not doing much at all.

What is the BoC to do?  Well the foreign exchange markets have already decided that the era of interest rate tightening is already over, and in fact in full reverse-- just look at the mortgage rates on offer from Canadian banks -- bottom line the BoC's interest rate normalization project is dead in the water, back to the rest of the world where zero interest rate policy (with all its risks) is back on.

For foreign investors the news is good -- after all Canada is still a resource rich country, with a reasonable debt position (when compared to the other guys) and where a relatively homogenous population ensures that no armed insurrection will occur (unless you count the occasional snow ball fight).  Overall, the BoC is back at square one -- the same place it was 18 months ago, except that for all its effort the CAD has dropped by about 10% (maybe that was the objective...).

The policy tools available to central banks are narrower than they were 10 years ago.  Changing demographics is a key issue here; an ageing population may not react the same way as a young one when rates change -- they are rate givers (net savings) and not rate takers (young indebted families).

The challenges for Canada are as follows:

  1. Despite near full employment workers don't have much bargaining power for wage increases
  2. Inflation, despite massive growth in money supply (insert definition here), is not occurring
  3. Canada is far more open than it was 20 years ago, the tools the BoC has grown up with are no longer effective -- a corporation that sells its goods in US dollars will match its borrowing requirements to reduce the currency risk impact using natural hedges.  This corporation is not impacted by the BoC
  4. Canadian banks are bigger today and better capitalized -- there BoC has only moral suasion (which failed recently when Canadian banks reduced prime mortgage rates despite the wishes of the BoC)
  5. New tools are required and maybe new measures of inflation too -- although StatCan is a specialist in terminating data series
Fundamentally, OECD economies are finding that population shift are impacting economic management tools -- if you think its bad here, imagine China -- where the one child policy implemented in 1979 is now "coming home to roost" with a dramatic drop in the growth of the labour pool.  Try managing that problem when Chinese companies will have to fight for new employees... What is being seen in a rather massive way in China is seen in a milder format here in the OECD.  Economists have yet to figure out what economic tools can be used to influence the economy.

Finally, on inflation and the various index we look at:  In America the price of a Big Mac has risen by 5.8% per annum over the past 10 years -- between 2004 and 2004.  Now that's not scientific.  A house in Montreal in in 2005 is now 50% more expensive than it was then -- that too is part of inflation -- unless you never moved, which statistically is wrong since 40% of Canadian move every 5 years.


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