Inflation – What is it?

For those of you who aren’t quite sure what inflation is, here is a brief tutorial.

Essentially, inflation is measured as the year over year percentage change in the consumer price index. Your next question might be “what the heck is a consumer price index?”. The consumer price index (or “CPI” for short) is defined as…

A measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.

So inflation measures the y/y percentage change in the basket of consumer goods and services that make up the consumer price index, which measures the average cost of living for Canadians.

What is the difference between Core Inflation and Inflation?

There are two common measure of inflation that are reported on by the Bank of Canada known as Core Inflation and general Inflation. The difference is that Core inflation excludes  8 of the most price volatile components in the CPI basket of goods and services. Those excluded components are fruit, vegetables, gasoline, fuel oil, natural gas, mortgage interest, inter-city transportation and tobacco products.

Below is a graph of inflation and core inflation since the beginning of 2008. As you can see the inflation rate has hovered in the range of -1% to 4%. When the inflation rate is negative it is called “deflation”.

Does the Bank of Canada have a target for the rate of Inflation?

Yes. This is known as the inflation control target which is currently set at 2%. This 2% target is the mid point in the acceptable control-target range of 1% – 3% that the Bank of Canada strives to maintain inflation levels within. If inflation levels exceed the control-target range then the Bank of Canada will usually take action to bring inflation rates back in line by adjusting interest rates.

Why is inflation important to track?

Inflation is important to track for several reasons. First of all it gives you a sense of how quickly your purchasing power is deteriorating. If the rate of inflation is higher then your annual wage/salary increases then you are losing real purchasing power. Additionally, comparing inflation to the control target range that the Bank of Canada tries to maintain will give you a good indicator on the future direction of interest rates. If the inflation rate is high the Bank of Canada will increase interest rates to cool the economy. If the inflation rate is low the Bank of Canada will lower interest rates in an attempt to stimulate the economy and avoid deflation.

Where can I find more information and statistics on inflation?

The best place to find more info on inflation is the Bank of Canada website or Statistics Canada.