Bank of Canada could confuse price signals with aggressive monetary policy


Commentary

Inflation, measured by the Consumer Price Index (CPI), rose sharply in all developed countries in 2021, including Canada, up 3.4% from the average annual growth rate of 1.88% from 2000 to 2020. did.

Following an official statement that inflation is temporary and primarily due to COVID-related supply chain disruptions, the Bank of Canada has recently begun to raise interest rates and begin to reduce government bond holdings. Suggested. Tighten.

Central banks now seem to think that the current inflation problem also reflects rising consumer spending. Monetary tightening (which also includes interest rate hikes) aims to reduce aggregate demand for goods and services (including housing) by raising the cost of loans and mortgages.

Still, some economists and business analysts are concerned that central banks can act “too aggressively”, especially to destabilize inflation. We’ll talk more about this soon.

Most Canadians understand the obvious consequences of inflation. For example, high-income families are more likely to own real estate and other assets, and their value usually increases during periods of significant inflation, which is an implicit tax that weighs heavily on low-income families.

But in a broader sense, the prices of certain inputs and outputs (such as used cars) rise at different rates throughout the inflation cycle, making it more difficult for sellers to determine whether production should increase. increase. And it’s better for workers to assess whether their services are in greater demand, or whether the prices they can charge are rising, or whether the rewards they can earn are simply in line with inflation. It will be difficult.

All of these results are oversupplied in some markets and overdemanded in others. This can return to the potentially volatile effects of central banks on inflation.

If inflation is relatively stable over the long term, suppliers need to know when rising prices indicate an increase in shortage. After that, we will respond by increasing the supply. Similarly, they should learn when higher prices simply reflect general inflation, not an increase in the rarity of their particular commodity or service. However, if inflation fluctuates significantly from year to year, producers and workers will not be able to identify when it is economically advantageous to increase or decrease the amount of goods and services they supply to the market.

In fact, higher inflation usually involves what economists call “greater absolute fluctuations” determined by standard deviation. This volatility increases with an absolutely large number in any set of numbers. For example, if Canada’s inflation rate averaged 6.95% annually from 1970 to 1989, the standard deviation of annual inflation rate during that period averaged 3.1%. By comparison, if inflation averaged 1.99% from 1990 to 2020, the standard deviation was only 1.01%.

However, note that the standard deviation was just above 50% of the average inflation rate from 1990 to 2020, compared to 45% in the previous period. Therefore, one might argue that yearly inflation fluctuations have caused relatively much noise in the pricing system during periods of relatively low inflation rather than periods of relatively high inflation.

Perhaps the policy message from inflation data is that central banks should lock inflation around relatively stable targets. Whether that target is 1 percent or 3 percent each year is arguably less important to economic efficiency than consistently achieving the target inflation rate.

The views expressed in this article are those of the author and do not necessarily reflect the views of The Epoch Times.

Stephen Grover Cleveland

follow

Steven Globerman is a resident student at the Fraser Institute.