One of the biggest economic trends worrying people right now is the rise in inflation. Over the last year, the costs of many products have gone up faster than they have in decades. But even if the inflation surge is temporary, it could raise inflation expectations, and that could have a long-term impact on the level of inflation, interest rates, economic growth, and markets.
Except for the period when gasoline prices surged in 2008, inflation is now rising faster than it has in nearly 30 years. The sudden reopening of the economy, propelled by massive government support, created enormous increases in demand, while supply chain and labor constraints limited output. This classic demand-exceeding-supply inflationary environment has provided businesses with significant pricing power.
Most likely, the current inflation acceleration will moderate over the next year. Businesses will have more time to adjust output, while the government’s payments to households and businesses will largely disappear, moderating sales. Supply and demand will become more in balance.
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So why worry about inflation? Because there is another concern that is not being discussed: Inflation expectations may be starting to get out of hand.
What are inflation expectations and why do we worry about them?
Inflation expectations are what households and business believe the rate of inflation will be over time.
Expectations of how costs will increase are crucial factors in business and household decision making. If a firm thinks its costs will rise by a certain level, it will need to find ways to cover those added expenses. It will look to improve productivity, but it will also likely need to raise prices.
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On the household side, inflation affects purchasing power. People can spend their income now or save it and buy goods in the future. The higher the rate of inflation, the less that can be bought in the future. As inflation rises, spending gets shifted from the future to the present.
And, finally, interest rates could be affected. The rate that financial institutions charge for loans depends in part on the need to offset inflation. Their buying power is negatively affected the same way as households’, and they need to cover that potential loss. The higher the expected rate of inflation, the higher the loan rate.
The implication is that we need to watch not just the rate of current inflation, but what is happening to expectations about what inflation may be over time.
And inflation expectations are on the rise.
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There are a variety of indicators of inflation expectations, but the trends are similar in just about every method that they are measured.
For example, the Atlanta Fed’s Business Inflation Expectations Index reached a level in June that is about 50% higher than it had typically been running. The University of Michigan’s measure hit its highest level in 13 years in May.
The St. Louis Fed’s May Breakeven Inflation Rate indexes are all at their highest level in about a decade. Even the survey of Professional Forecasters (of which I am a member) indicated that inflation expectations are increasing, and it takes a lot to get economists to change their long-run forecasts.
Though not every index has inflation expectations surging, it is critical that this issue be watched carefully because the 800-pound gorilla in the economic policy room, the Fed, worries greatly about what is happening to this indicator.
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The key for the Fed is that inflation expectations don’t change greatly. This was highlighted in a 2007 speech by former Fed Chair Ben Bernanke when he said this: “Undoubtedly, the state of inflation expectations greatly influences actual inflation and thus the central bank’s ability to achieve price stability.”
The Fed has two primary goals, price stability and maximum employment. Those two mandates can come into conflict. If inflation is rising too rapidly, the Fed would need to slow growth. But that could affect employment levels. If unemployment is too high, the Fed might want to increase growth, but that could lead to rising inflation.
For Fed policy to work best, inflation expectations need to be largely insulated from the ebbs and flows of the daily flow of data. If that is the case, expectations are described as being well “anchored.”
When expectations change significantly and it appears that movement could be sustained, the Fed might have to alter policy to prevent the expectations from getting too high, because businesses would start factoring inflation into their economic decisions. “Unanchored” expectations could cause inflation to accelerate, forcing up interest rates.
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Related to the anchoring of expectations is the concern that the perception of the rate of long-term inflation could change. It’s been decades since businesses have had the pricing power they now enjoy. Similarly, except for the baby boomers who lived through the periods of rapid inflation in the 1970s and early 1980s, few people have given inflation much thought over the last 20 years or more.
It is possible that an extended period of higher-than-“normal” inflation could fundamentally change both business and household perceptions of what the “normal” inflation rate will be over time.
The higher inflation rates and interest rates that would result from an upward shift in inflation expectations would affect everything, from mortgage rates to equity markets.
We are not near a point where the Fed must react to the change in inflation expectations. There are frequent ups and downs in the measures. But the longer the increase continues, the greater the likelihood the Fed will have to respond, and that could mean it starts raising rates.
Indeed, an enduring gap up in inflation expectations is not inevitable. But this indicator needs to be watched carefully as a more lasting change could affect the economy and the markets significantly.
Joel L. Naroff is the president and founder of Naroff Economics, a strategic economic consulting firm in Bucks County.
OTTAWA – Canada’s unemployment rate held steady at 6.5 per cent last month as hiring remained weak across the economy.
Statistics Canada’s labour force survey on Friday said employment rose by a modest 15,000 jobs in October.
Business, building and support services saw the largest gain in employment.
Meanwhile, finance, insurance, real estate, rental and leasing experienced the largest decline.
Many economists see weakness in the job market continuing in the short term, before the Bank of Canada’s interest rate cuts spark a rebound in economic growth next year.
Despite ongoing softness in the labour market, however, strong wage growth has raged on in Canada. Average hourly wages in October grew 4.9 per cent from a year ago, reaching $35.76.
Friday’s report also shed some light on the financial health of households.
According to the agency, 28.8 per cent of Canadians aged 15 or older were living in a household that had difficulty meeting financial needs – like food and housing – in the previous four weeks.
That was down from 33.1 per cent in October 2023 and 35.5 per cent in October 2022, but still above the 20.4 per cent figure recorded in October 2020.
People living in a rented home were more likely to report difficulty meeting financial needs, with nearly four in 10 reporting that was the case.
That compares with just under a quarter of those living in an owned home by a household member.
Immigrants were also more likely to report facing financial strain last month, with about four out of 10 immigrants who landed in the last year doing so.
That compares with about three in 10 more established immigrants and one in four of people born in Canada.
This report by The Canadian Press was first published Nov. 8, 2024.
The Canadian Institute for Health Information says health-care spending in Canada is projected to reach a new high in 2024.
The annual report released Thursday says total health spending is expected to hit $372 billion, or $9,054 per Canadian.
CIHI’s national analysis predicts expenditures will rise by 5.7 per cent in 2024, compared to 4.5 per cent in 2023 and 1.7 per cent in 2022.
This year’s health spending is estimated to represent 12.4 per cent of Canada’s gross domestic product. Excluding two years of the pandemic, it would be the highest ratio in the country’s history.
While it’s not unusual for health expenditures to outpace economic growth, the report says this could be the case for the next several years due to Canada’s growing population and its aging demographic.
Canada’s per capita spending on health care in 2022 was among the highest in the world, but still less than countries such as the United States and Sweden.
The report notes that the Canadian dental and pharmacare plans could push health-care spending even further as more people who previously couldn’t afford these services start using them.
This report by The Canadian Press was first published Nov. 7, 2024.
Canadian Press health coverage receives support through a partnership with the Canadian Medical Association. CP is solely responsible for this content.
As Canadians wake up to news that Donald Trump will return to the White House, the president-elect’s protectionist stance is casting a spotlight on what effect his second term will have on Canada-U.S. economic ties.
Some Canadian business leaders have expressed worry over Trump’s promise to introduce a universal 10 per cent tariff on all American imports.
A Canadian Chamber of Commerce report released last month suggested those tariffs would shrink the Canadian economy, resulting in around $30 billion per year in economic costs.
More than 77 per cent of Canadian exports go to the U.S.
Canada’s manufacturing sector faces the biggest risk should Trump push forward on imposing broad tariffs, said Canadian Manufacturers and Exporters president and CEO Dennis Darby. He said the sector is the “most trade-exposed” within Canada.
“It’s in the U.S.’s best interest, it’s in our best interest, but most importantly for consumers across North America, that we’re able to trade goods, materials, ingredients, as we have under the trade agreements,” Darby said in an interview.
“It’s a more complex or complicated outcome than it would have been with the Democrats, but we’ve had to deal with this before and we’re going to do our best to deal with it again.”
American economists have also warned Trump’s plan could cause inflation and possibly a recession, which could have ripple effects in Canada.
It’s consumers who will ultimately feel the burden of any inflationary effect caused by broad tariffs, said Darby.
“A tariff tends to raise costs, and it ultimately raises prices, so that’s something that we have to be prepared for,” he said.
“It could tilt production mandates. A tariff makes goods more expensive, but on the same token, it also will make inputs for the U.S. more expensive.”
A report last month by TD economist Marc Ercolao said research shows a full-scale implementation of Trump’s tariff plan could lead to a near-five per cent reduction in Canadian export volumes to the U.S. by early-2027, relative to current baseline forecasts.
Retaliation by Canada would also increase costs for domestic producers, and push import volumes lower in the process.
“Slowing import activity mitigates some of the negative net trade impact on total GDP enough to avoid a technical recession, but still produces a period of extended stagnation through 2025 and 2026,” Ercolao said.
Since the Canada-United States-Mexico Agreement came into effect in 2020, trade between Canada and the U.S. has surged by 46 per cent, according to the Toronto Region Board of Trade.
With that deal is up for review in 2026, Canadian Chamber of Commerce president and CEO Candace Laing said the Canadian government “must collaborate effectively with the Trump administration to preserve and strengthen our bilateral economic partnership.”
“With an impressive $3.6 billion in daily trade, Canada and the United States are each other’s closest international partners. The secure and efficient flow of goods and people across our border … remains essential for the economies of both countries,” she said in a statement.
“By resisting tariffs and trade barriers that will only raise prices and hurt consumers in both countries, Canada and the United States can strengthen resilient cross-border supply chains that enhance our shared economic security.”
This report by The Canadian Press was first published Nov. 6, 2024.
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