Bank of Canada deputy governor Paul Beaudry says returning inflation to the central bank’s two per cent target is critical because high and volatile inflation makes the economy inefficient and businesses less competitive.
In a speech at the University of Alberta on Thursday, the deputy governor says low and stable inflation go together, noting data shows inflation becomes more volatile the higher it is.
Canada’s inflation rate was 6.3 per cent in December compared with a year earlier as it continues to decline from a peak of 8.1 per cent set in June. Next week, Statistics Canada is set to release January’s inflation data.
In addition to making future financial planning harder for people and businesses, Beaudry says volatile inflation “makes it hard to judge whether a higher price represents a true change in costs or something else.”
When inflation is around the two per cent target, the deputy governor says firms adjust prices less frequently and must stay competitive with each other.
But when inflation is high, it’s easier for businesses to pass on larger price increases with less pushback from consumers, he said.
“If people don’t believe they can find a better price by shopping around, firms have more leeway to increase markups, leading to distortions that make the economy less efficient and consumers worse off,” Beaudry said, adding that such an outcome would make it harder to grow the economy and employment in a sustainable way.
The deputy governor said the distortionary effects of inflation explain why the Bank of Canada can’t allow inflation to “remain significantly above target for too long,” even if inflation has been falling more recently.
The deceleration has been encouraging to economists and the Bank of Canada, which announced last month it will take a pause from raising interest rates.
On Jan. 25, the Bank of Canada announced a final interest rate hike and said it would take a pause to allow the economy some time to respond to higher interest rates.
With the key interest rate at 4.5 per cent – the highest it’s been since 2007 – the Canadian economy is expected to slow significantly this year as people and businesses pull back on spending.
As this process unfolds, the Bank of Canada is forecasting inflation will fall to three per cent by mid-2023 and back down to two per cent next year.
However, the central bank has made it clear that it will be ready to jump back in and raise rates further if inflation proves to be stickier than anticipated.
Beaudry’s speech Thursday emphasizes that the Bank of Canada not only wants to see a deceleration in inflation – it needs it to fall back to the two per cent target soon.
“When it comes to inflation, stability begets stability and volatility produces volatility,” he said.