False alarm?

From the June 2022 print edition

At the onset of the COVID-19 pandemic two years ago, I did something I had not done for almost five years. I started going to the grocery store regularly. When my wife and I got married seven years ago, we agreed that she would be a stay-at-home mother and run the house, while I would basically hold two full-time jobs to support the family. This worked very well for all of us, until the lockdowns upset the Hlinka household’s applecart. If you recall, for several months the only “acceptable” reason to leave your house was if you were shopping for food.

There were two stores that we would visit weekly: No Frills (for basics) and Whole Foods. We’re simple people and there were several items we would always buy at No Frills: No Name potato chips, No Name soft drinks, No Name instant coffee, No Name pasta, bacon, eggs, hamburger meat and various fruits and vegetables. Here’s something I noticed when I compared prices from April 2021 to April 2020. The cost of some products – particularly bacon and hamburger meat – had risen sharply, while the price of the No Name products had stayed the same.

That got me thinking. No Name products might be understood as “inferior goods.” What’s an inferior good? It’s a product where there is an inverse relationship between your income and the quantity you buy. In other words, the wealthier you are, the less you consume.

I noticed that not all prices were rising uniformly. The more desirable foods (or “normal goods”) were becoming more expensive.

It seemed to me that what we were looking at was demand-pull inflation. This made sense. People couldn’t spend their money on the usual range of goods and services, so they treated themselves with better food.

Fast forward to April 2022. I went to No Frills and the No Name coffee that had cost $5.99 two years before was now $6.49. The 200-gram bags of potato chips that had been $.99 were now selling for $1.29. It seems that the inflation story has pivoted and now we are looking at cost-push inflation. Higher input costs are compelling manufacturers to raise prices. But the important question is whether we are amid an inflationary cycle or is this more like a one-off phenomenon due to the fallout from COVID-19.

What’s inflation?
I probably should have started this column by defining inflation. We generally think that when prices
of things go up, we’re experiencing inflation. And this is true in one sense. But to a trained economist, inflation is an ongoing phenomenon where higher prices lead to higher prices, which in turn lead to higher prices. I’ve seen a couple of these cycles in my lifetime. In 1973, inflation was 7.5 per cent. It then spiked to 11 per cent and 10.7 per cent over the next two years. Then in 1980, inflation hit double-digits at 10.1 per cent, then 12.5 per cent and 10.8 per cent in 1981 and 1982, respectively.

The fear right now is that history could repeat itself. Inflation is currently running at an annualized rate of 6.8 per cent in Canada. It’s even worse in the US, where inflation has exceeded 8 per cent in the past three monthly reports. We’ve seen central banks on both sides of the 49th parallel increase interest rates to cool things off and there is the expectation that more hikes are coming. There is the danger that this could push the economy into recession, as happened in the early 1980s. But in a sense, the Bank of Canada is between a rock and a hard place. Or is it?

I’ve got a contrarian view on this. The economy was shut down for months. At the same time, money was being pumped into the system. As Milton Friedman pointed out years ago, inflation is always a “monetary phenomenon.” In simple English, an economy will experience inflation when there is an imbalance between supply and demand. However, that has been largely corrected. Things are pretty much wide open with only minimal restrictions. Higher food and gas prices are forcing consumers to spend more of their budget on necessities which will reduce demand for other products.

We should remember that there are some strong anti-inflationary pressures. This year, Canada will welcome more immigrants than ever before which will have the impact of dampening wage growth. Yes, supply and demand holds in labour markets. Oil currently exceeds $110 per barrel and I wouldn’t be surprised to see that cut in half as early as a year from now. The biggest danger our economy faces right now isn’t inflation, it’s tepid growth. And this will be a persistent and long-term problem. And it’s much more worrisome than higher prices.

Toronto-based Michael Hlinka provides business commentary to CBC Radio One and a column syndicated across the CBC network.