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July 9, 2019 –  Inflation went through a puzzling path after the financial crisis of 2008-09 and the reasons why warrant a closer look, according to a C.D. Howe Institute report.  In “Inflation after the Crisis: What’s the Story?” authors Jeremy Kronick and Farah Omran explore a link between the breadth of economic growth and inflation performance over the period following the financial crisis.

Economists have faced two strange puzzles in the inflation rate since the financial crisis: “missing disinflation” during a period of slumping major economies that lasted from 2009 to 2011; and “missing inflation” during much of the economic expansion that has occurred since then.

“The missing disinflation puzzle was characterized by constant or even increasing inflation, despite significant economic slack from the global financial crisis,” notes Kronick.  “The missing inflation puzzle, which has lasted much of the time since, has the exact opposite description: despite economic rebounds and closing output gaps, headline inflation remains below target for many inflation-targeting central banks. “ In Canada’s case, headline inflation, which includes commodities with volatile prices, has averaged 1.56 percent from January 2012 to the end of May this year, well below the Bank of Canada’s 2 percent target.

The authors find missing disinflation occurred when economic growth, though low, was spread across many industries. By contrast, missing inflation occurred when growth was higher but concentrated in a smaller set of industries.

One possible explanation for the link between breadth and inflation is different spending by different income quintiles. It is possible that the more widespread, or less concentrated, growth is, the more resources are spread across different income quintiles, rather than concentrated at the top. This matters since lower income households tend to spend a higher percentage of their income, driving up inflation. The authors find, for example, that  the sectors that grew the most, such as accommodation, fuel and other basic living needs, and  propped up inflation during the missing disinflation period, were those where lower-income households spent a disproportionately larger proportion than higher-income households. Similarly, sectors that contracted the most, and dampened inflation during the missing inflation period, were those where lower-income households typically spent relatively more.

 “The robustness of this link suggests that the industry makeup of economic growth matters for inflation behaviour, and as a result, matters for monetary policy,” says Omran. “Going forward, the Bank of Canada could use this tool to help assess the path of inflation.”

Read the full report

The C.D. Howe Institute is an independent not-for-profit research institute whose mission is to raise living standards by fostering economically sound public policies. Widely considered to be Canada's most influential think tank, the Institute is a trusted source of essential policy intelligence, distinguished by research that is nonpartisan, evidence-based and subject to definitive expert review.

For more information contact: Jeremy Kronick, Associate Director, Research, Farah Omran Junior Policy Analyst, or Laura Bouchard, Communications Manager, C.D. Howe Institute: phone 416-865-1904 ext. 9935; email: lbouchard@cdhowe.org