Will inflation be a horror or a healthy readjustment? Economists clash over the basics

It has been recognized for thousands of years, but inflation remains a subject of continued dispute, including over why it happens, what to do about it and even whether it is good or bad.

Why is this happening, how long will it last, is it good or bad? It depends who you ask

A living statue of Sir Isaac Newton. The scientist and mathematician battled inflation as Master of the Royal Mint in the U.K. This week, financial markets will be waiting anxiously to see how close Canada's inflation rate comes to the U.S. gain of 6.2 per cent. (Yves Herman/Reuters)

What happens in Vegas stays in Vegas, but as Bank of Canada governor Tiff Macklem recently remarked, the same thing does not apply to what happens in financial markets.

"It has real impacts," Macklem told the U.S. Council on Foreign Relations in October. And this week, some newly released data from that very month is likely to prove him right.

On the heels of U.S. inflation figures that last week shocked politicians and unsettled markets, Canada will get its own October reading on rising prices on Wednesday.

From Nero to Newton

For a phenomenon observed in Nero's Rome and studied by some of humanity's best minds, including Sir Isaac Newton — who besides transforming physics with his laws of motion battled inflation as Master of the Royal Mint — modern scholars remain surprisingly divided on the subject.

If history is any guide, periods of inflation can lead to turmoil. This week, financial markets will be waiting anxiously to see how close Canada's inflation rate comes to the U.S. gain of 6.2 per cent.

But even if price increases reach only five per cent by year's end — a number suggested by Macklem himself at the last monetary policy news conference at the end of October — price changes at those levels could have an increasingly negative effect on the lives of Canadians.

Those effects include the pain of shrinking spending power, the prospect of labour conflict as employees struggle to get their spending power back, a potential disruption of Canada's soaring housing market and a reconsideration for older people about how to make their money last through a long retirement.

CUPE members picket outside the New Brunswick Legislature in Fredericton on Friday. In the past, demands for wages to catch up to inflation have led to increased labour strife. (Jacques Poitras/CBC)

Just as in the United States, where opponents of President Joe Biden are using inflation to attack government policy, some Canadian critics say rising inflation will have negative consequences for Canada's governing Liberals.

Of course, that depends on whether you think the current bout of inflation is good or bad, what has caused it, what the remedies might be and how long it will last. Canadians who imagine economics as a discipline with clear rules and definitive outcomes may be surprised to find that all of those things remain in dispute.

Inflation good or inflation bad?

Last week, commentator Jon Schwarz, writing in The Intercept, offered a take on the economic argument for why inflation is good — a sort of natural repair mechanism for an economy out of whack. 

"Inflation is bad for the 1 per cent but helps out almost everyone else," says the headline at the top of Schwarz's story.

The nub of the argument is that for people who have big loans, inflation makes them smaller in dollar terms. As wages and prices inflate, loans can be paid off in inflated dollars. For lenders or people with piles of cash, the effect is the opposite.

It is clear that those saving for retirement may take a different view, especially as the boomer bulge exits the labour market. Even before the latest round of pandemic monetary stimulus, people contemplating a long retirement complained about a paltry return on savings. With inflation higher than the rate of interest, cautious savers are now watching with horror as their future spending power shrinks.

While inflation helps those burdened by debt, it can hurt baby boomers facing a long retirement by depleting their savings. With inflation higher than the rate of interest, people who have been diligently saving are now watching their future spending power shrink. (Jeff Chiu/The Associated Press)

And that disparity is not just on the side of savers. As Hilliard MacBeth, an Edmonton-based financial adviser and author of When the Bubble Bursts, observed, even before the latest U.S. inflation surprise, lenders have been handing out mortgages at rates considerably less than the rate of inflation.

"Even three per cent makes no sense in a 5.4 per cent [consumer price index] world," MacBeth tweeted.

But as he points out, that depends on whether you think inflation is settling in for the long term or, as central bankers have long insisted, it is a short-term, "transitory" effect caused by events tied to the COVID-19 pandemic.

Mortgage loans boost money supply

University of British Columbia economist Michael Devereux believes one-time impacts, such as the shipping bottleneck, are the main forces driving rising prices. But like others, he is not sure the inflationary effect will disappear once Canadians grow to expect it. People may keep demanding higher wages and businesses higher prices as they try to catch up with inflation.

Another strong contender for inflation's cause — a flood of new money into the economy caused by the central banks themselves — has led to heated arguments among economists.

A simple graph demonstrating the relationship in a Financial Post commentary by Simon Fraser University economist Herbert Grubel prompted a response from the University of Calgary's Trevor Tombe, with a graph showing the exact opposite or no relationship at all.

Complicating the picture in Canada are the billions of dollars being created out of thin air by the housing boom, as outlined in a short and sweet analysis by Canada's Library of Parliament.

In Canada's soaring housing market, growing mortgage loans from banks are the largest source of money creation. (Cole Burston/Bloomberg)

"The majority of money in the economy is created by commercial banks when they extend new loans, such as mortgages," says the report, published in May. As mortgage loans grow alongside soaring real estate values, the impact is much greater than central bank bond buying.

The idea that inflation is caused by a flood of money chasing a limited amount of goods, pushing up the price of those goods, has the virtue of feeling intuitively correct, but as our central bankers continually tell us, economies are not static. They say a little extra stimulus is still needed to use up spare capacity, making the economy stronger and more productive.

The trouble with trying to understand inflation — like trying to understand any complex system — is that human brains, not being omniscient, cannot comprehend all of the economy's working parts. And in such an interdependent system, it may be false to imagine there is a discrete cause or a simple solution.

At the beginning of last week, Macklem was widely quoted as saying that Canadian inflation was "transitory but not short-lived."

WATCH | Rising food prices contribute to 18-year-high inflation:

Rising food prices contribute to 18-year high inflation

2 years ago
Duration 2:30
Featured VideoThe continued increase in food prices is a major contributor to Canada’s inflation rate reaching an 18-year high and some economists say the rising costs could last longer than initially thought.

By that measure, all inflation is transitory, because it comes for a while and then, months or years later, it disappears again.

But one thing many economists seem to agree upon is that in the short term, central bankers must begin to raise interest rates, probably sooner than they had planned only months ago.

As disruptive as they may be for those who believed the majority view just last year that inflation and rates would remain tame, rate hikes won't be an instant fix. Studies show their inflation-fighting power can take two years to come into full effect.

Follow Don on Twitter @don_pittis


Don Pittis

Business columnist

Based in Toronto, Don Pittis is a business columnist and senior producer for CBC News. Previously, he was a forest firefighter, and a ranger in Canada's High Arctic islands. After moving into journalism, he was principal business reporter for Radio Television Hong Kong before the handover to China. He has produced and reported for the CBC in Saskatchewan and Toronto and the BBC in London.

With files from Alexander Panetta in Washington