What is inflation?
Inflation is the steady rise in the price of goods and services in an economy over time.
Three causes of inflation
Prices generally rise when the demand for a good or service is higher than the supply of that good or service. There are 3 ways this can happen.
Cost-push inflation
This happens when the demand for something stays the same while the supply falls because of higher production costs such as raw materials or wages.Rising gas pricesare an example of this type of inflation.
Demand-pull inflation
This occurs when the demand for a product or service rises significantly and the supply in the economy can’t meet that demand. The global economic recovery from the pandemic is an example of this type of inflation. Consumer demand for good and services that weren’t available for many months is increasing, while supplies of those good and services can’t keep up. The result is high prices.
Built-in inflation
This happens because consumers get used to the idea that current inflation rates will continue, and therefore expect wage increases tomaintain their standard of living. This wage increase results in a higher cost for good and services, and the cycle repeats.
How inflation is measured
Economies measure the rate of inflation using the change in consumer price index (CPI). Statistics Canada calculates the CPI by tracking the month-to-month change in prices for a sample basket of 700 goods and services Canadians typically purchase.
If in 1 year, that basket cost $100, but the next year the same basket cost $102, then the average rate of inflation would be 2%.
Is inflation good or bad?
According tothe Bank of CanadaOpens a new website in a new window, a low, stable and predictable inflation rate is good for the Canadian economy. If businesses and consumers believe they know what the inflation rate will be going forward, they can plan for the future. This leads to an economy that functions better and grows.
The Bank of Canada tries to keep inflation close to 2% because it believes at that rate the demand for goods and services is almost equal to supply.
If the inflation rate is below 2%, the Bank of Canada lowers interest rates to encourage businesses and companies to borrow, spend and invest.
If the inflation rate is higher than 3%, the Bank of Canadaraises interest ratesto slow down borrowing and spending to bring the economy closer to demand equalling supply.
According to aJuly 2022 surveyOpens a new website in a new window, 71% of Canadians follow the Bank of Canada’s interest rate adjustments closely or very closely, while 24% aren’t watching as closely and 5% aren’t following at all.
What high inflation does
When prices rise too quickly, consumers can’t afford to buy as much which lowers their standard of living. As well, people, businesses and investors don’t know what their costs will be. This instability and unpredictability hurts the economy.
High inflation is most difficult for pensionersand low wage earners whose incomes may not be able to keep pace with inflation, lowering the value of their incomes and savings.
Hedging against inflation
Hedging is a way to manage financial risk. An inflation hedge helps protect you from falling purchasing power.
Investing in equities are a great way to combat inflation because rising stock prices include the impact of inflation. In addition, purchasing equities using dollar-cost averaging also helps to hedge against inflation because you’re purchasing stocks at a range of prices from lower to higher.
Managing high inflation as a consumer
There are several ways you can weather periods of high inflation as a consumer.
- Delay large purchases(such as vehicles or home renovations) until demand and prices fall
- Watch your grocery spendingby buying in bulk, price matching, using coupons, using grocery store points plans, or meal planning
- Pay off debtespecially high-interest credit card debt if you can
- Drive lessby carpooling, grouping errands, taking public transit, cycling or walking
- Track all your spendingto keep a closer eye on everything you purchase and determine where you might be able to spend less or not spend at all
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