- Canada gets the top ranking for inflation among the peer countries, receiving an “A” grade along with 10 others.
- Inflation has ceased to be a headline issue among the peer group for now, largely because these economies have operated below their growth potential since the 2008–09 recession.
- Japan and Switzerland receive a “C” because they suffered general price deflation, which can dangerously depress conditions for consumption and investment and hold back economic growth.
Putting inflation in context
Inflation was a serious problem for Canada—and many other industrial countries—in the late 1970s and 1980s, peaking at 12.5 per cent in 1981. Two upward oil price shocks and accommodative macroeconomic policies were the key factors behind this inflationary period. But since 1992, inflation in Canada has generally been kept below 3 per cent.
Inflation is measured by keeping track of the cost of a basket of goods and services used by a typical consumer. With a Canadian inflation rate of 1.52 per cent in 2012, a basket of goods that cost $100 in 2011 would cost $101.52 in 2012. Ultimately, inflation erodes the purchasing power of consumers; that is, it reduces the quantity of goods that can be purchased with a given amount of money.
Hyperinflation—or “out of control” inflation—can lead to the breakdown of a country’s monetary system and to social and political unrest.
Deflation—the sustained fall in prices for a broad range of goods and services—is also harmful to economic security. Deflation usually occurs during a recession and hurts consumption, production, and employment.
How do we grade inflation performance?
We award an “A” grade to inflation that falls within the Bank of Canada’s inflation-control target range, which is between 1 and 3 per cent. Inflation outside this target range (either above or below) gets a lower grade. The further away from the target range, the lower the grade.
Countries with inflation between 0 and 1 per cent or between 3 and 4 per cent earn a “B” grade. We grade inflation between 0 and 1 per cent to be a “danger zone” because it may signal that a country is slipping toward deflation. The one exception is when inflation between 0 and 1 per cent is due to currency appreciation or strong productivity growth—these countries get an “A.”
Inflation between 0 and −2 per cent (i.e., deflation) or between 4 and 6 per cent gets a “C.” The lowest grade, “D,” is given if inflation is above 6 per cent or if prices are falling by more than 2 per cent, an indication of severe deflation.
How does Canada’s performance compare to that of its peers?
Using our methodology, Canada fared better on the inflation front in 2012 than all of its peers. Eleven peer countries, including Canada, receive an “A” grade for inflation performance in 2012. The continued strong Canadian dollar, sluggish economic growth, and easing commodity and housing prices all helped to keep Canada’s inflation in check.
Japan and Switzerland receive a “C” for 2012 because they experienced price deflation, which can create dangerous depressed conditions for consumption and investment and hold back economic growth. Japan in particular has been drifting in and out of deflation since the early 1990s. Not surprisingly, Japan has suffered weak economic growth and repeated bouts of recession over that period.
Why is inflation bad?
High inflation reflects a volatile economy in which money does not hold its value for long. Workers seek higher wages to cover rising costs and are not inclined to save because the cost of goods and services is expected to be even higher in the future. Producers in turn may raise selling prices to cover cost increases, and cut back production to control their costs (resulting in layoffs).
Citizens on fixed incomes—like many pensioners—are particularly hard hit by high inflation. While the wealthy can usually protect themselves against inflation by investing in assets—such as stocks, bonds, or property—that increase in value during periods of inflation, those on fixed incomes find the value of their income eroding. If the inflation rate is 6 per cent, someone on a fixed-income pension is unlikely to receive a 6 per cent income increase to compensate, and so that person’s purchasing power is reduced. This leads to an increase in income inequality, or a growing gap between the “haves” and the “have-nots.”
Hyperinflation—“out of control” inflation—can lead to the breakdown of a country’s monetary system and create social and political instability. Some notable cases of hyperinflation include Germany in 1923, when prices doubled every two days, and Yugoslavia in 1993, when prices doubled every 16 hours. Zimbabwe now has the most inflationary conditions, along with severe political and social turbulence. Canada has never experienced hyperinflation.
If deflation reduces the price of goods, why isn’t it a good thing?
Price declines due to productivity gains or new sources of supply can be beneficial. But deflation is something entirely different and generally bad for the economy. Deflation is the simultaneous sustained fall in prices for a broad range of goods and services. A country will always have some goods or services with falling prices, like the decline in the cost of computers or cell phones. But deflation causes increases in real interest rates (interest rates adjusted for changes in prices), triggering loan defaults. Consumers also postpone purchasing goods and services on the bet they will be cheaper tomorrow. When deflation occurs, businesses can no longer sell their products, leading them to cut back on production and employment. This leads to even lower demand for goods and, in turn, to lower prices.
Historical experience has shown that once deflation is set in motion, it is extremely difficult to stop, as Japan has found out. Japan has been drifting in and out of deflation since the early 1990s, and is still grappling with how to address it.
Has Canada’s inflation performance improved since the 1970s?
Inflation was a headline issue in Canada in the 1970s and early 1980s. The first spike was in 1974, when inflation rose sharply to 11 per cent, mainly as a result of the dramatic increase in oil prices, what some have called “oil price shock.” Prices for items such as housing and food followed suit. In response to the higher cost of living, unions went on strike to increase wages. World commodity prices also rose sharply. The Canadian government responded by instituting wage and price controls, which curbed inflationary pressures for several years. These controls were phased out in 1978.
The second spike was in 1981, when inflation hit 12.5 per cent. Tighter monetary policy cut inflation by half within two years. Annual inflation did not rise above 6 per cent between 1983 and 1991. And since 1992, the Bank of Canada’s subsequent inflation-targeted monetary policy has generally kept inflation below 3 per cent.
Except for Switzerland and Germany, all peer countries received a “D” grade in the 1970s because of average inflation rates above 6 per cent. Dramatic inflation declines in the 1980s in several countries earned them an “A.” In the 1990s and 2000s, most countries, including Canada, had tamed inflationary pressures and received “A” grades.
Use the drop-down menu to compare the change in Canada’s inflation rate with that of its peers.