Inflation has turned negative for the first time since the Great Recession, the latest reminder that the COVID-19 crisis is wreaking havoc on an historic scale.
Statistics Canada on May 20 reported that the Consumer Price Index dropped 0.2 per cent in April from a year earlier, the first decline since September 2009, after increasing 0.9 per cent in March. The primary cause was all the strange and terrible things that have been happening in international oil markets, with the year-over-year cost of gasoline plunging 39.3 per cent, the largest decrease on record.
Excluding energy prices, the CPI rose 1.6 per cent, as five of eight components posted increases. Still, an official statistic that even hints at deflation is hard to look at, especially when the central bank has emptied its armoury to put upward pressure on prices.
“The downward impact of energy prices on the total price index will dominate,” Arlene Kish, director of Canadian economics at IHS Markit, a data and research firm, said in a note. “Therefore, expect total consumer price inflation to stay low for a while longer.”
It’s probably best to look away from the inflation numbers for a while, or at least gaze through them to a time in the future when the economy has returned to something closer to normal. There is more noise in these data than signal.
The government-mandated economic lockdown has crunched both supply and demand, not one or the other, so it’s more difficult to guess how businesses and households will respond to stimulus. The crisis is also changing consumer behaviour, making data based on traditional spending patterns unreliable. The cost of clothes and shoes dropped 5.9 per cent, another record decline. But does that herald a deflationary trend? Probably not, as long as the careful reopening of provincial economies that began this month continues.
“The shutdown is not typical,” Timothy Lane, the longest-serving deputy governor on the Bank of Canada’s policy committee, said in a speech on May 20. “These shifts mean the standard consumer price index, based on the cost of a fixed basket of goods, is less meaningful.”
Statistics Canada is aware of the measurement issues. However, overhauling proven statistical methods is a lot like developing a vaccine: you need time to run the tests. The agency has little choice but to stick with its existing basket of goods, which is based on things Canadians were buying in 2017. The agency said it would continue with its current methodology until it sees enough data to determine whether any new spending habits are permanent or transitory.
Overhauling proven statistical methods is a lot like developing a vaccine: you need time to run the tests
The central bank doesn’t have the luxury of waiting, so it will have to feel its way in real time. The Bank of Canada sets interest rates to keep the CPI at about two per cent, and that “remains our objective,” Lane said. Getting a read on the situation will be the first big test for Tiff Macklem when he takes over as governor in the first week of June.
“We are working to assess the impact that these shifts in spending patterns can have on measured inflation,” Lane said. Policymakers have observed that Canadians are spending less on restaurant meals, airfare, clothing and gasoline, and a lot more on groceries and pharmaceutical products. “Overall, the results indicate that the decline in inflation experienced by consumers may be less than indicated by the official CPI measure,” he said.
It’s easy to assume that prices rise and fall with economic growth. But it’s more complicated than that. An economy can race ahead if it has the productive capacity to satisfy demand without putting upward pressure on prices. The inverse is also true. Inflation can accompany a downturn if too much capacity is destroyed. Stephen Poloz, the Bank of Canada’s current governor, warned politicians of the latter during the trade wars, just in case they assumed the central bank would be there to offset the negative effects of their tit-for-tat tariffs. The message he delivered then applies now: it’s not that simple.
“We are likely to emerge from the shutdown with both demand and supply weaker than before,” Lane said. “The scarring associated with the shutdown could lower productivity, which tends to result in higher inflation. But the bank’s analysis suggests that the decline in demand stemming in part from weaker business and consumer confidence is likely to have a larger effect. On balance, there is likely to be downward pressure on inflation.”
Inflation has been a non-story in Canada for years. Even last year, when most of the world’s central banks were cutting interest rates, the Bank of Canada stayed the course because the CPI was increasing at an annual pace of about two per cent, exactly where policymakers wanted it.
The smooth ride is over. Poloz and his deputies survived the trade wars, but at least they had a target. Macklem’s central bank will be aiming into the fog.