By Dr Nicholas Li, PhD, Toronto Metropolitan University — The Conversation, 18 August 2022
Inflation is one of the most pressing political and economic issues of the moment, but there are many misconceptions about how inflation is measured, where it comes from, and how it impacts the average person. In June 2022, inflation in Canada reached a 40-year high of 8.1%. Statistics Canada constructs the Consumer Price Index (CPI) through a two-step process: first collecting over one million price quotes on virtually anything purchasable in the country, then aggregating these prices by weighting each item’s price change by its share of total consumer spending. Items with prices that change quickly — like food or gasoline — are collected more frequently than items with steadier prices like insurance or university tuition.
Prices are determined by supply and demand, and high inflation is a sign that, across the economy, demand for goods and services exceeds their supply. Demand has been strong due to strong employment and wage growth, cheap credit, pandemic-related government payments, and pandemic-related shifts in demand towards goods consumed at home. Supply has been disrupted by the pandemic’s effects on Chinese factories, international supply chains, container shipping, trucking, and the Russian invasion of Ukraine that led to recent spikes in food and energy prices. Many people feel like prices rose by more than the measured rate — partly because we tend to notice price changes for items we purchase frequently, and we tend to notice price increases more than decreases. The items with the highest price increases — energy and food — have these characteristics. High inflation has winners and losers: individuals who earn no or below-inflation wages are hurt, while individuals with wages indexed to inflation can benefit. Seniors on fixed incomes are often hurt, and the homeless and poorest communities face the greatest hardship. Central banks and governments must decide whether to curb demand and risk recession by raising interest rates, cutting spending or raising taxes, or wait and hope that supply-side inflation pressures ease up on their own. This article has been republished under Creative Commons licence.