A better way to cool inflation is to make Canadian workers more productive
Rising prices are hitting people hard in the pocketbook. And it is not just the sky-high and soaring home prices anymore. A visit to a grocery store or gas pump can lead to sticker shock and dining out has become even more of an extravagant luxury than it was before. Almost everywhere we look, we see higher prices or, to put the collective term on it, inflation.
Inflation has been defined as too much money chasing too few goods. Canada, like many other countries, is still awash with the waves of dollars that governments distributed to prevent the pandemic from adding economic misery to the physical and psychological harm that Covid 19 had already done. Much of these funds remain in people’s bank accounts.
Apart from the strictly monetary aspects of inflation, we need to look at the real economy, namely the goods and services themselves and not just their prices. Here is where the fundamental tools of supply and demand come into the picture. When the supply (actual or potential) of any good or service decreases, the price goes up and vice versa. The opposite applies to demand.
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The pandemic has negatively impacted the supply of many goods through lockdowns and transportation disruption. The domino effect of each shortage hurts the next link in national and global supply chains. Disasters such as earthquakes, wars and extreme weather events also take a toll on supply, and we have been having far too many of those recently.
As supply diminishes, demand, as reflected in spending, rises. Headlines keep reminding us that, rather than being curbed to fight inflation, government spending is galloping out of control, aided by ongoing deficit budgets.
About two-thirds of overall demand in the economy is for consumption. Despite all the fearmongering about an upcoming recession, consumer spending is still increasing. There are at least three reasons why.
First are the previously mentioned pandemic-related funds that governments distributed and are still not spent.
Second is what has been termed revenge spending. After almost three years of Covid-caused lockdowns, constraints, uncertainties and fears, the psychological need to splash out and get back to normal or even a little bit better than the old normal is great. This phenomenon is most obvious in the travel industry but can also be found in other sectors.
The third and probably the most significant and long-lasting contributor to rising consumer demand is a booming labour market. Unemployment rates are at the lowest level in decades, with the number of vacant jobs exceeding the number of people looking for work. Just about anyone who wants a job (or a better job) can find one, and wages are moving up. Rising wages can add to the upward pressure on prices.
Given this supply and demand situation, it is no wonder we have inflation. The wonder is that inflation is not higher than it is and that current inflation rates are beginning to moderate.
The major policy tool now being used to get inflation back down to a desirable level (usually two per cent) is the interest rate. Textbook theory says that increasing interest rates will mean less investment (spending by business) and less consumer spending, thus reducing overall demand and hence prices. Despite significant and rapid increases in interest rates, consumer spending is still increasing, and any impact on investment has not been enough to bring inflation under control.
There may be a better way to cool inflation than pushing rates up to the point where spending is heavily curtailed and the economy is forced into a recession. Instead of cutting off demand, can we increase supply?
One way to do this is to make our workers more productive. If output is growing, rising wages are no longer inflationary as they represent an increase in actual output. Greater supply dampens price pressure.
To get this greater supply, make workers more productive, justify higher real wages, and improve our standard of living, we need capital investment. Many factors influence the level of capital investment, but a major one is interest rates. Lower rates mean more investment, more productivity and more output and less upward push on prices. We are now moving interest rates up, not down. Do we have our monetary policy backward?
Dr. Roslyn Kunin is president of the Vancouver Institute and has been chair of the Vancouver Stock Exchange, WorkSafe BC, and Haida Enterprise Corporation. She has also been on the boards of the Business Development Bank of Canada (BDC) and the National Statistics Council.
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