November 14, 2023 – Canada’s headline Consumer Price Index (CPI) has recently experienced one of the most pronounced accelerations and decelerations in the pace of change in decades – hitting 8.1 percent year over year in June 2022 and declining to 2.8 percent by June 2023. What’s driving inflation's recent rise and fall in Canada?
In “Rise, Stall, or Fall: The Key Drivers Behind Inflation’s Path in Canada,” authors Yu (Sonja) Chen and Trevor Tombe measure product-level price changes and identify whether the forces impacting inflation are mainly supply-driven (i.e. energy prices, wages or other input costs) or demand-driven (i.e. consumer expenditures, fiscal policy, etc.). To quantify the direct contribution of individual items to changes in the aggregate CPI, the authors categorize all products into five key product categories: energy, groceries, shelter (excluding energy), services (excluding shelter), and goods (excluding groceries and energy).
While the future path of Canada’s inflation remains uncertain, Chen and Tombe find that most of inflation’s decline can be attributed to the falling price of energy – a product directly purchased by households and an input in the production of nearly all goods and services.
In particular, energy contributed 2.2 percentage points to the overall 4.3 percentage point fall in the year-over-year change in Canada’s average consumer prices between June 2022 and September 2023, meaning the direct effect of lower energy prices accounts for just over half of inflation’s overall decline. “This is large,” says Tombe.
On the service sector side, shelter costs have been the main driver of persistent high costs. For instance, services excluding shelter contributed 0.3 percentage points to the overall 3.8 percent growth in the CPI for September 2023, while shelter costs excluding energy contributed 1.7 percentage points. Despite some reductions, however, the authors note that many of these categories are contributing more than their averages before the COVID-19 pandemic.
Although both supply- and demand-side factors have played a role in inflation, a substantial reduction in demand-driven factors account for most of the overall fall in the pace of consumer growth. As well, Chen and Tombe find no evidence of the growing influence of labour costs on price increases and only modest evidence that higher interest rates have begun to reduce the pace of demand-side price increases among goods that are historically sensitive to monetary policy.
Today, a greater portion of the remaining price pressures stem from supply-side factors, especially in housing and groceries.
“Given the persistence of supply-side price pressures, it may be necessary for the Bank of Canada to continue implementing a robust tightening of monetary policy to counteract the effects originating from the supply side, and to preserve well-anchored inflation expectations,” conclude Chen and Tombe. “But this may come with a higher economic cost.”
For more information contact: Yu (Sonja) Chen, Assistant Professor of Economics, University of Calgary; Trevor Tombe, Professor of Economics, University of Calgary, and Research Fellow, The School of Public Policy, University of Calgary; and Lauren Malyk, Communications Officer, C.D. Howe Institute, 416-865-1904 Ext. 0247, lmalyk@cdhowe.org
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