Canada’s Inflation Woes: Seeking Solutions for Our Economy
On Tuesday (August 15), Statistics Canada delivered news that resonated with dissonance among Canadians—a surge in July's inflation rates from 2.8% to 3.3%. This untimely development emerges against the backdrop of widespread affordability challenges coursing through the nation. A somber realization dawns—this uptick marks well over a year of government efforts to rein in inflation to a desired 2% rate, efforts that have regrettably fallen short. A myriad of contributing factors influences this economic landscape, with some garnering more attention than others. Amidst these complexities, pivotal questions emerge: Why does inflation endure, and why do the government's policy tools not yield the desired urgency and effectiveness demanded by Canadians? Delve into this commentary for insights into these persisting questions.
Interest Rates
A tried-and-true method to curb inflation has been the strategic elevation of interest rates. This deliberate move serves to curtail the borrowing capacity of both Canadian enterprises and everyday citizens alike. As borrowing potential dwindles, the subsequent decrease in demand acts as a natural brake on economic momentum, ideally resulting in a decline in inflationary pressures. The Bank of Canada (BoC) has adeptly employed this approach for an extended period, spanning well over a year. Notably, since March of 2022, the BoC has implemented ten rate hikes, progressively elevating them from 0.50% to a substantial 5.00%. This orchestrated series of actions by the BoC has notably and appreciably decelerated the pace of inflation. However, despite these measured steps, the specter of persistent inflation continues to cast a shadow over the Canadian economy.
A pertinent example of this challenge surfaced in the recent inflation report released on Tuesday, which revealed an uptick in inflation to 3.3%. This resurgence of inflationary pressures underscores the delicate equilibrium that the BoC must navigate. As the central bank grapples with this complex situation, the prospect of another round of rate hikes emerges on the horizon. This prospective move by the BoC reflects an ongoing determination to exert further control over the economy's pace, with the overarching goal of chipping away at the stubborn remnants of inflation that persistently linger.
The Housing Crisis Fueling the Fire
The historical benchmarks that have long illustrated the interplay between interest rates and inflation rates are notably deficient in accounting for a pivotal determinant driving Canadian inflation in 2023: the constrained supply within the housing market. A definitive illustration of this can be found in the recent StatsCan report released on Tuesday. This report underscores how mortgage interest costs, surging by an astonishing 30.6% in a year-on-year comparison, stand as a principal catalyst behind the inflationary pressures experienced in the month of July.
The prevailing scarcity of both accessible and reasonably priced housing options nationwide is widely acknowledged. Unlike historical patterns, the demand within the housing market does not show signs of abating in tandem with rising inflation or interest rates. Instead, the sustained escalation of interest rates has introduced a new impediment for potential homebuyers striving to enter the market. It has simultaneously compelled existing homeowners to contemplate alternative housing options, including downsizing or transitioning to rental arrangements that align with more economical choices.
As a result, this situation has led to an increased demand within the rental sector, causing a general upward trend in rental rates. Landlords, grappling with heightened costs resulting from elevated rates, have been compelled to raise monthly rents to counterbalance these growing expenditures. Heightened interest rates fall short in effectively addressing the core issue: the dampening of housing demand nationwide. As long as this factor remains a prevailing force, inflation will persist.
The shortage in housing is also being exacerbated by the increase in interest rates as builders cancel projects due increased costs affiliated with rising interest rates. Earlier this week the Toronto Star reported that 22% of Canadian homebuilders have canceled projects due to lower sales projections and increased costs in labour and materials. The report went on to state that, overall, homebuilders are pessimistic about market conditions in Canada leading many builders to press pause or consider pressing pause on housing projects.
These external consequences created by the increase in interest rates begs the question of; can Canada’s persistent inflation problem be solved by the steady increase in interest rates by the Bank of Canada? The short answer is; not in the short term. The Bank of Canada can only raise interest rates incrementally as many Canadians are over extended on debt. To effectively counter inflation stemming from housing market demand, interest rates would need to soar into the double-digit range. However, this proposition presents significant challenges. Incrementally raising rates to such levels is a time-consuming endeavor for the Bank of Canada, leading to a delay in tackling inflation in the short term. Moreover, the prospect of interest rates reaching double digits unavoidably exacerbates the ongoing affordability crisis that is already gripping the economy, potentially impacting more Canadians.
An illustration of the affordability crisis becoming evident occurred in July, when the Federal Government provided a grocery rebate to low-income households as a measure to alleviate the financial strains caused by inflation. The Over Stimulated Economy section of this article will consider the effectiveness of this move. There is no-doubt that an increasing number of Canadians are struggling with affordability, however, that number as reported through the grocery rebate is concerning. Those who paid careful attention to the eligibility for the grocery rebate learned that 11-million Canadians were making below $38,000/year. To put that number in perspective, the poverty line in Canada is considered $43,500. This signifies that 28% of the Canadian population resides below the poverty line. Consequently, if interest rates were to double or even triple to 10% or 15%, the number of Canadians unable to afford housing and groceries would see a significant surge. It's evident that relying solely on interest rates as an economic instrument to counter inflation is an inadequate approach in the short term.
Over Stimulated Economy
In July, Deputy Prime Minister and Finance Minister Chrystia Freeland addressed the media as the “grocery rebate” was set to be sent out to low-income Canadians to offset the strain inflation had placed on their finances. The grocery rebate ranged from $225-$467, depending on household circumstances, and there was no requirement for this rebate to be spent on groceries. This sudden infusion of cash flowing into the economy likely contributed somewhat to the rise in inflation in the month of July.
Deputy Primer Minister and Finance Minister Chrystia Freeland
More generally, the economy is over stimulated by government spending. The federal deficit projections provided in the 2023 budget stand at $40.1-billion. Many provinces, such as Ontario, are projecting budget deficits in the billions of dollars in 2023-24 as well. In a round about way, as the government attempts to assist those suffering from increased affordability in Canada they are exacerbating the issue though enormous annual budgets, which in turn over stimulates the economy and drives inflation. Cutting the federal deficit by even 25% would like help in slowing inflation rates to a more acceptable number.
Charting a Path Forward
In light of these intricate dynamics, solving Canada's persistent inflation puzzle requires a balanced approach. While interest rate adjustments play a role, they fall short in countering the underlying housing demand. To solely rely on interest rates as a solution is a limited perspective, with potential adverse consequences for those already grappling with affordability. Balancing targeted interventions, fiscal restraint, and a nuanced understanding of housing dynamics will be crucial in steering Canada's economy toward a more sustainable course and tackling the ever-persistent specter of inflation.
