No one has to study inflation to know its effects. If you earn money, it buys less. If you owe money at a fixed rate of interest, you’re getting a huge break because you’re paying back those loans with weaker purchasing power dollars than what you borrowed.
Opinion is divided about whether inflation is the worst thing that can happen to an economy. Generally speaking, economists and other policy wonks think falling prices – deflation – is worse, because once the downward spiral begins, it’s almost impossible to stop it. Falling prices means lower revenue and profit margins for companies, which leads to layoffs, less hiring, stagnant wages, and outright pay cuts. Consumers with lower incomes have less money to spend, which locks the cycle in place. With sales down, firms cut prices more to get business. Then everybody realizes that prices are falling, and nobody wants to buy today if it will be cheaper tomorrow.
No one is talking deflation today. Today, inflation is the enemy and everyone who speaks on behalf of governments or central banks speaks the same language: interest rates are the combat weapon of choice and pushing them up will vanquish the enemy. The headline news has primed us for sharp increases in interest rates, followed by the slowing of everything that has depended on cheap money, followed maybe by higher unemployment, recession and… praise be – back to 2% inflation.
We should be so lucky. A few things stand in the way of this not-quite-idyllic trajectory.
Monetary policy – the mechanism by which interest rates rise or fall – does not act with surgical precision. It is more like a sledgehammer because of the indeterminate time it takes for an interest rate hike to work its way through the various parts of the economy – mortgage rates, savings rates, the construction industry, the service sector. Moreover, government spokespeople and central bankers may seem to be saying the same things, but often they are acting in opposing directions: the central bank raises rates to influence you to spend less and the government announces new spending programs to blunt the effect of the interest rate hike. Think of Prime Minister Trudeau’s recent announcements to double the Goods and Services Tax Credit (GSTC), direct payments of up to $1,300 per child over the next two years for dental care services and a one-time top-up to the Canada Housing Benefit to deliver $500 to 1.8 million Canadian renters as battering rams aimed squarely at the interest hike sledgehammer.
Then there is the theory that inflation and unemployment have an inverse and stable relationship – when inflation is up, unemployment is down, so to get inflation down, just push unemployment up. This may have been a reasonable belief when there were lots of people looking for jobs, but it’s hard to say how it works when people don’t exist to fill all the jobs. Almost everywhere in the world, there aren’t enough workers because the population is ageing out of the workforce and we aren’t having enough babies to replace them. This is called a structural shortage. It’s not going to be corrected by driving up unemployment. The only way to keep people in the workforce and possibly attract them back is to offer them more money and/or improve their working conditions.
Some things about the future we can say with a degree of certainty:
Reality doesn’t always follow the playbook of theory.
Politicians, policy wonks and central bankers say they are a united front, but they often work at cross-purposes.
We citizens are always the guinea pigs.
We need our own “best interest” financial and life plan.
Dian Cohen, C.M., O.M., economist
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