Should I Worry About Inflation?

September 25, 2021

The subject of inflation seems to be on everyone’s mind right now. As people slowly return to work, to school, and to social activities, it is hard to ignore the fact that prices of almost everything seem to have gone up with no apparent end in sight.

How much? That depends on the commodity.

Gasoline, for example, dropped to a low of 60 cents a litre at the outset of the pandemic in March 2020. Now regular unleaded gasoline in Ontario is hovering around $1.40 a litre (and higher in Quebec).

Fruit and vegetable prices have skyrocketed, as have the prices of furniture, appliances and vehicles. And of course, housing prices have gone through the roof.

Should you be worried about this jump in prices? Is there anything that can be done about it? Is there anything you can do?

What is inflation?

Without getting too technical, inflation is a substantial and continuous increase in the prices of goods and services.  In Canada in 2020, the inflation rate was 0.72% which is substantially lower than the inflation rates of previous years (see below).

Fiscal Year Inflation Rate

Undoubtedly the outbreak of the COVID-19 pandemic contributed to the unusually low increase in 2020. But more recently, prices have started to increase substantially. The year over year inflation rate in Canada in August 2021 was 4.1%, the biggest jump since March 2003. That’s up from 3.7% in July and 3.1% in June 2021.

The Bank of Canada which is responsible for managing the monetary supply through various activities such as setting base interest rates or buying or selling various securities, established a goal of maintaining the inflation rate in Canada between 1% and 3%. Clearly that threshold has now been breached, so bankers, economists, business owners, politicians, and ordinary folks are clamouring to find out why we are in this new round of inflation and what can be done about it.

What causes inflation?

Sometimes an unpredictable external event can trigger a round of inflation—for example, a pandemic or severe weather conditions. A political conflict, poor policy, or financial decisions—for example providing too much credit to businesses or consumers—can also create a new round of inflation.

Right now, the major central banks are trying to determine whether the current inflation situation is temporary or structural. We know that COVID-19 caused major shutdowns around the country in 2020, throwing many people out of work and severely hampering Canadian businesses. This also affected the supply of many goods and services, creating shortages resulting in higher prices.

The Government of Canada responded with a number of large and expensive programs, such as the Canadian Emergency Response Benefit (CERB) and the Canadian Emergency Rent Subsidy (CERS), to help employees and business owners stay afloat until normalcy was restored. But those programs also in some ways may have distorted markets. For example, some workers receiving CERB found it more convenient or even more financially attractive to stay home. As the CERB winds down, they are now somewhat reluctant to return to their old jobs. This shortage of labour has disrupted businesses such as restaurants and hotels, forcing them to reduce hours or close altogether.

Will this situation be temporary? Will people eventually return to their previous jobs? Or will there be a whole new set of workplace conditions, such as higher wages, broader benefits, more time off, etc.? Only time will tell if the impact is temporary or permanent, and what other areas might be affected such as commercial rents, municipal and federal taxes, etc. A recent survey by the Bank of America found that 69% of American investors feel the current wave of inflation is only temporary. But as more data comes out, we will have a clearer picture of what is happening.

What can governments and central banks do to reverse the course of inflation?

As mentioned, government has a number of policy instruments which it can use to try to get inflation under control. For example, in the past, governments have tried to institute price controls through legislation (e.g., the “6 and 5” program). But government intervention can also lead to unintended consequences. For example, some politicians recently have floated ideas about new programs to support first-time homebuyers. But this could have a consequence of sending house prices even higher or escalating the rise in prices of essential commodities such as lumber or steel.

Central banks (the Bank of Canada) can try to reduce the amount of money in circulation by increasing interest rates, making it more difficult and expensive for businesses and consumers to borrow. This is a very tricky area, and a misstep or a move too early or too late could create exactly the wrong outcome. Often central banks will use moral suasion—well-placed hints—to try to “talk down” prices without having to intervene.

Are there strategies to protect against inflation?

Ordinary individuals are also caught in the spiral of inflation. One obvious strategy is to reduce your spending by reducing your personal expectations. Put off that major purchase until price levels subside. Recently we have seen the price of lumber go up to unprecedented levels, only to come down quickly to pre-pandemic prices. There has been some pushback in recent months in some hot housing markets in Canada, although limited when compared to year-over-year increases in home prices.

Another strategy might be to pay off personal debt and reduce borrowing until prices decline to more realistic levels. If inflation continues to rise, so too will interest rates and the cost of borrowing. Some people remember mortgage rates as high as 17% in the 1980s. While this is unlikely to happen now, it shows how overpaying for a home can severely affect one’s financial situation if inflation gets out of hand.

Should you worry about inflation?

Inflation is a serious issue that affects everyone. But its impact depends very much on a person’s personal situation. Are you a student? Are you just starting out in the workforce? Are you planning a family? Are you an aspiring new business owner?

Some people may actually benefit from inflation. For example, if you are a homeowner, you will likely benefit from price increases if you are mortgage-free or have a long-term mortgage. But if you are a renter or first-time homebuyer, you will see inflation affect your finances negatively.

While it may not always be obvious, inflation can eat away at your savings and standard of living by silently reducing your purchasing power. If inflation is running at 3.5% and you are saving your money in the bank at a 0.5% interest rate, or holding bonds that pay 1-1.5%, you are losing ground. If you are working under a long-term contract where the cost-of-living allowance is below 3.5%, you are also losing ground. So too if you are retired and on a fixed pension.

Where can I get advice to deal with inflation?

The best way to protect yourself against inflation is to stay informed. Seek advice from a financial advisor, an accountant, or some other business professional to ensure that you are managing your affairs in a way that properly considers the effects of inflation. Have a long-term plan, because inflation will inevitably subside. Find out how inflation affects you—because it does.

Ian Sadinsky | Writer

Life. Beyond numbers.
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