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Why Canada’s inflation rate is so high: Opinion

Higher interest rates are not solely due to factors beyond our control. Our own overspending is primarily responsible

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Canadians will find no comfort in Statistics Canada’s announcement of September’s inflation figures on Wednesday. Consumer prices rose 6.9% in September from a year earlier. Sure, that’s a notch down from last month’s 7.0%, but prices continue to rise rapidly, especially food at 10.3% and housing at 6.8%. Together, the two represent 45% of average household consumption.

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Therefore, expect the Bank of Canada to continue raising interest rates next year. Excess demand for labor – almost a million jobs are unfilled – means that inflation will persist. Even though companies will reduce the availability of jobs as the demand for their production declines, many will still be looking for workers. Persistent labor shortages allow workers to bargain harder for higher wages to compensate for the loss of purchasing power of their money. So expect GDP growth to stagnate while unemployment barely increases. Significantly higher interest rates could eventually lead to a generalized recession.

Politicians will soon blame inflation on external factors: Putin’s war, oil restrictions imposed by Saudi Arabia or international food shortages. But here is a riddle. Why does Canada have an inflation rate nearly two and a half times that of China, Japan and Taiwan, all of which were 2.8% year-over-year in their last month. Even Hong Kong, Saudi Arabia and Switzerland have inflation rates less than half ours. All of these countries have also been affected by international trends, but their inflation rates are significantly lower than ours.

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The answer may not be so complicated. Using a little-noticed paper published by the US Federal Reserve last July, I find that countries with large spending sprees in 2020 tended to have much higher inflation rates in 2022. The relationship is not not perfect in the 15 countries examined by the article, but it is striking that the combination of above-expected spending in 2020 and accommodative monetary policy that year appears to have done much harm. It may have avoided an economic haemorrhage during the pandemic, but it has led to cost inflation in 2022.

As the table shows, the United States recorded the largest spending spree in 2020 – 18.1% – and also the highest rate of broad money growth – 17.2%. And now it has the highest inflation rate except for the UK. Canada was second to the United States with a 17% deviation from projected spending and a 13.8% growth in money supply. At the other end of the spectrum, China did not increase its spending in 2020 and although its money supply growth was 10%, its inflation rate was modest in 2022. The odd country is the Japan, which had a big 15.2% spending spree, but less accommodative monetary policy, which translates into relatively low inflation today.

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Do international trends play Nope role in inflation? No way. In fact, the Federal Reserve study finds that one country can be directly affected by fiscal expansion in other countries. He estimates that 1.7 percentage points of our inflation comes from US foreign fiscal expansion. In other words, the Biden administration’s reckless spending is pushing Canadian interest rates even higher.

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Overspending at home in 2020 has resulted in two “taxes” for Canadians. The first has already materialized with wage increases below inflation rates, leading to a decline in the purchasing power of individuals’ incomes. It is as if the government increased the GST/HST for everyone. The second is the sharp rise in interest rates, which reduces the valuations of stocks and bonds.

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Another loss that is rarely mentioned is the insufficient indexation of government transfers and income tax brackets last year. The indexation used monthly data from October 2020 to September 2021 and was only 2.4%, only half the actual 2021 inflation rate (year-over-year from December 2021). There will be a catch-up in 2023 when the new indexation factor is expected to be 9.2%, which will likely be higher than the annual rate in 2022. But not all income tax bases are fully indexed, including capital income and corporate profits. Certain transfers either: the Child Tax Benefit, for example, is not indexed until July 1st.

Inflation hurts. The same goes for higher interest rates. And they are not solely due to factors beyond our control. Our own overspending is primarily responsible for this.

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