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How does Canada protect against inflation?

9 min read

How does Canada protect against inflation?

Written By

April Ann Quiñones

Rounding it up

  • Inflation in Canada is a measure used to determine the success of Canadian monetary policy.

  • The inflation rates rose to 4.1% in August last year, recording the highest inflation rate since 2003.

  • Currently, inflation in Canada is higher than normal.

  • In 2021, the main areas affected by inflation included energy costs like gasoline and fuel, food, and homeownership.

  • There are measures that Canada has taken to hedge the inflation effects and protect its citizens.

  • The Bank of Canada and the Government of Canada set an inflation target of 2%

Although inflation in Canada remains lower than in most countries, investors, consumers, and workers can still feel its effect. In this article, we will look at inflation in Canada and the measures being taken to hedge the residents against its effects.

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What is Inflation?

Inflation is a useful indicator that most investors and economists use to measure price changes of goods and services over time. It helps measure the gross domestic product (GDP), the unemployment rates, and the overall economic health.

The Bank of Canada uses inflation to monitor different things that affect the economy, including unemployment. Its monetary policy helps to address the long-term price changes. The Consumer Price Index, an indicator of inflation, increased to up to 3.4% in 2021, the highest inflation rate experienced in the country since 1991.

In Canada, abnormal inflation rates are caused by various factors. One cause is the disruptions experienced in the global supply chain during the pandemic. The pandemic caused most companies to stop producing goods and services as before due to shortages in raw materials and labour supply, disrupting the supply chain.

Also, the COVID-19 zero policy in China has significantly affected the production of most manufactured goods. This has caused delayed shipping in most ports.

The other main cause of inflation in Canada is an increase in demand for goods that were previously unavailable during the pandemic. With the increase in these goods, a high inflation rate is expected. Furthermore, the widespread drought experienced in the country has impacted the food supply, contributing to an increase in inflation.

The Inflation Transitory in Canada

To better understand the current Canadian inflation and determine whether it is high or low, we need to look at it from a historical perspective. This is crucial because inflation rates in Canada have been different throughout the years.

During World War II, the government board controlled the wages and prices of consumer goods, and most savings were put in war bonds. This led to a massive hike in inflation to 18%.

In 1950, a monetary policy was established, causing a drastic decrease in the inflation rates with lows of 0% and highs of 4%. In the period between 1955 and 1970, inflation was considered to be under control, hovering between 0% and 5%, with an average of 2.5%.

It was during this period that Canada experienced economic growth since inflation was subdued under the Canadian monetary policy. The period between 1959 and 1961 saw a shift from the Canadian monetary policy to the Coyne Affair. This emanated from a dispute between the then Governor of the Bank of Canada, James Coyne, and the Diefenbaker government.

The dispute concerned the monetary and economic policy, where Coyne thought the government’s idea to pursue expansionist policies was not viable. He instead advocated for sound money, despite the high unemployment rates.

The matter was taken before the House of Commons, where it voted in favour of the Diefenbaker government. However, the policy did not go through because the Senate rejected it.

In the period between 1970 and 1990, Canada experienced extremely high levels of inflation.

The inflation levels increased in 1971 when the United States adjourned the possibility to convert U.S. dollars to gold. This makes it possible for it to inflate its money supply without any restrictions.

Consequently, it became hard for Canada to maintain the fixed exchange rate with the U.S., leading to extremely high inflation levels. These levels continued to rise to 12% in 1975 when the Arab oil embargo increased oil prices. The inflation rate continued to increase further to 12.8% in 1981 and later dropped to 4% in 1984. The inflation rate then rose to 5% in 1991.

Current Inflation in Canada

Historically speaking, Canada’s high inflation cannot be termed as high inflation. Today, Canadian residents are paying higher prices for food, used cars, and gasoline, considering that the supply chain was affected by the pandemic. When there is a rise in inflation, consumers are forced to dig deeper in their wallets to purchase goods and services.

For this reason, the Bank of Canada continuously strives to ensure that inflation in Canada is stable and predictable. Unfortunately, the global pandemic has made inflation unstable and unpredictable.

According to Statistic Canada, the prices of goods and services have increased, reaching up to 4.1% in August 2021. As the country recovered from the pandemic and travel restrictions eased, the demand for goods and services increased. Consequently, the prices of goods and services have also increased.

Why Stabilizing the Inflation Rates is Crucial

There is no denying that high inflation can be damaging to an economy. With this economic impact, both individuals and companies find it costly to purchase and produce goods.

The other downside of inflation is the uncertainty that comes with it. Inflation causes uncertainty when it comes to the prices of goods, and this increases the cost of living. This is because it affects the normal operations of the pricing system, which are usually determined by the demand for goods and services.

When a market economy experiences inflation, it gets difficult for markets to convey useful information that guides the allocation of resources in an economy. Therefore, a world of inflation becomes very difficult to understand and make decisions.

Stabilizing inflation is imperative, especially for those with large household debt. An increase in inflation increases the price of goods and services, and this decreases the purchasing power of the consumer. When this happens, there is little left to pay off debt.

Similarly, when inflation is high, interest rates also increase. An increase in interest rates means that more Canadian homeowners will have to part with more for debt repayment and will be left with less money for life’s necessities.

How Does Canada Moderate Inflation?

There are several ways that inflation is moderated and controlled in Canada. They include:

Inflation Targeting

For over 25 years, the rate of inflation in Canada has remained constant. This was after the Bank of Canada, and the Government of Canada agreed to set a target inflation rate of 2% in 1991 to ensure price stability.

This target guides the bank in making decisions for the appropriate interest rate to ensure a stable price environment. The inflation-control target is reviewed every five years.

To ensure consistency with the inflation target, the Bank of Canada has had to come up with several measures. This includes increasing the policy rate, which then leads to the Canadian banks raising their interest rates on loans and mortgages.

This, in turn, discourages Canadians from spending and borrowing. Since this lowers the demand for goods and services, most companies are forced to reduce their prices to encourage customers to make purchases. When this happens, inflation decreases, and Canadians don’t have to feel a pinch in their wallets anymore.

When the COVID-19 pandemic hit, there was a dramatic shift in the rate of inflation. The economy was greatly affected because of shortages in energy supply, raw materials, and high levels of government spending.

As the pandemic-related restrictions have been eased, there have been low inflationary pressures in Canada. According to policymakers, the prices of goods and services are not as high compared to when the pandemic hit. Besides, the Bank of Canada continues to maintain low interest rates to facilitate the country’s economic recovery.

Major Supports Indexed to Inflation

To prevent the poor from getting poorer, the Canadian government has indexed some of its support programs to inflation. With this, most low-income households can afford not only basic needs but also things like cars and houses.

The Government of Canada has indexed most of its support programs, including the Canada Child Benefit, Old Age Security, Canada Pension Plan and Employment Insurance, and Guaranteed Income Supplement. The provincial and territorial supports help to protect families with children, the aged, and sales tax rebates.

Most provinces in Canada offer additional support for low-income houses, which are generally indexed. For instance, Quebec offers all the major five support programs for low-income citizens, which are all indexed.

By making these Canadian programs universal, many low-income houses will be protected against the impacts of inflation.

On the downside, most social assistance programs are not indexed to inflation. Also, major support categories in provinces like Nunavut, Alberta, and NWT are not indexed.

Minimum Wages for Each Province

The other way that Canada protects its citizens against inflation is through minimum wages. Like the federal government, each province in the country has a minimum wage to help protect those with poor income. This is done by indexing the minimum wages to inflation.

Otherwise, most low-income households are left vulnerable due to high inflation. Provinces like Quebec have indexed 5 of the major categories of support, offering the most protection to the vulnerable against high inflation. However, not all provinces offer inflation protection for low-income earners.

Issuance of Inflation-Linked Bonds

Inflation-linked bonds can help protect your investments against a rise in inflation. Unlike traditional bonds, they can put a hedge over your purchasing power in the event of rising prices.

These bonds belong to a different asset class than that of traditional bonds and equities since their returns don’t compare with that of other fixed-income assets. Also, returns on ILBs are pegged to the Consumer Price Index, and this helps to protect your investment during inflation.

As a result, inflation-linked bonds can become useful when you want to mitigate vitality and promote diversification. In Canada, ILBs are issued by the central bank as Real Return Bonds (RRBs). Canada’s RRBs offer a hedge against inflation and promote diversification and portfolio balance.

The only issue is that RRBs could constitute more volatility since they have a longer duration to maturity. Longer maturity periods usually lead to an increase in interest rates, causing more volatility. The other issue is that they don’t provide inflation doors. This means that an increase in deflation could lead to capital loss at maturity.

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Printing Money

Mark Carney, Bank of Canada’s Governor, has established a monetary policy to keep interest rates low. Carney prints money to purchase treasury bills. This helps to keep short-term interest rates low.

An issue of this is that it can lead to excess money, which the central bank may be unable to handle. In the 1970s, economists believed that inflation was a result of excess money in the economy. As a result, the government adopted the monetarism approach to limit the money supply so that it matched the economic growth.

Encouraging Citizens to Invests in Inflation Contributing Stocks

This is yet another measure that can be taken to protect investors against inflation. Companies like energy firms do well in a high inflation environment since oil is a major contributor to inflation. Therefore, these companies can be encouraged to invest in energy stocks to break even.

A Long Road Ahead

By hiking the rates and ensuring tighter financial conditions, the Bank of Canada can help stabilize and bring down the inflation levels. However, this response may not impact other things like reducing gas prices. This is because the Canadian monetary policy helps to address long-term price changes but may not be helpful in improving the main causes of inflation in Canada today.

As consumer spending increases post the COVID-19 recession, the prices for goods are likely to rise. By understanding the effects of inflation and the measures taken to put a hedge over it, you will be in a better position to make decisions regarding spending, investing, and retirement planning.

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