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What’s causing higher inflation and why it could last years

Click to play video: 'Economists predict rising inflation is here to stay' Economists predict rising inflation is here to stay
WATCH: Canada is seeing a sustained increase in the cost of goods and services and economists say inflation could be with us for years. A number of issues, including changing consumer tastes and global supply chain issues, are contributing to problem. Anne Gaviola explains – Jul 28, 2021

When inflation reared its head in North America this spring, the common view was that it would be just a temporary bout of price increases. Now, though, many analysts aren’t so sure.

“Inflation rates of three, four — or yes, even five per cent — could be with us for a year or two,” says Douglas Porter, chief economist with Bank of Montreal.

Economists surveyed by the Wall Street Journal this month had a similar outlook for U.S. inflation, with forecasts of sustained price increases lasting until 2023.

South of the border, the pace of inflation accelerated to 5.4 per cent in June, the highest year-over-year increase in consumer prices the U.S. has seen in 13 years. In Canada, the annual rate of price increases reached 3.1 per cent in June, Statistics Canada said on Wednesday.

As widely expected, the pace of inflation in Canada eased last month compared to the 3.6 per cent year-over-year rate recorded in May, which was the largest annual increase since May 2011. Still, the slowdown was in part due to the comparison with June 2020, which saw a rebound in prices as the Canadian economy briefly emerged from the strict COVID-19 restrictions imposed at the start of the pandemic.

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Overall, north of the 49th parallel, inflation has so far remained more subdued than in the U.S, likely due to both economic factors and accounting differences.

Read more: Some salaries up ‘drastically’ as Canada feels impact of labour shortages

For one, Canada is further behind its southern neighbour on the path of economic recovery, Porter notes. The recent strength of the Canadian dollar, which has been trading at around $0.80 U.S., has also tempered inflationary pressures, Porter adds.

And then there’s the fact that used car prices, which have been a major driver of U.S. inflation, haven’t risen quite as much in Canada and aren’t included in Statistics Canada’s consumer price index, he says.

But even in Canada, the latest inflation data has raised red flags.

One reason why many had initially dismissed higher inflation rates earlier this year as transitory was the fact they reflected year-over-year comparisons with March and April of 2020, which had seen steep price declines due to the onset of the COVID-19 pandemic.

Read more: Rising interest rates will be ‘No. 1 issue’ for Canada’s housing market, economists say

But even measures of core inflation that strip out the more volatile components of the Consumer Price Index have climbed above the Bank of Canada’s two per cent inflation target, notes Steve Ambler, a professor of economics at the Université du Québec à Montréal and David Dodge Chair in Monetary Policy at the C.D. Howe Institute. In June, the annual rate of inflation excluding gasoline prices was 2.2 per cent, Statistics Canada said.

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“There’s reason for being a little bit worried about whether this can keep on or how long it will keep on,” Ambler says.

Click to play video: 'Used car shortage pushes prices to ‘crazy’ levels' Used car shortage pushes prices to ‘crazy’ levels
Used car shortage pushes prices to ‘crazy’ levels – Jul 22, 2021

The pandemic mismatch between supply and demand could have lasting impacts

At the heart of the current inflationary spell is a mismatch between demand and supply, economists say. On the one hand, soaring vaccination rates and loosening COVID-19 restrictions have quickly brought back demand from consumers who, after months cooped up at home, are eager to spend.

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On the other hand, the supply of goods and services Canadians and Americans have, in many instances, hasn’t ramped up fast enough.

Earlier this year, for example, lumber prices spiked as sawmills, which had pared back production right at the start of the health emergency, scrambled to meet skyrocketing demand from home builders and renovators amid the pandemic housing boom. In May, prices reached an all-time high of more than US$1,600 per 1,000 board feet, up from around US$400 per thousand board feet in February 2020.

Read more: Some used cars are now selling for as much as new models. Here’s why

It’s a similar story in the auto market. Car manufacturers dialled back their orders of microchips — essential for anything from infotainment systems to engines in new vehicles — when they scaled back production at the start of the pandemic. Now, automakers are having trouble getting their hands on enough of the chips, an issue that has slowed down the production of new cars and trucks and spilled over into the used-car market.

With fewer cars and trucks rolling off factory floors, more car buyers are turning to second-hand vehicles. At the same time, for the same reason, both drivers and rental companies are holding on to their vehicles for longer, which is reducing the number of used cars available for sale. The result is soaring prices for preowned vehicles.

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And while many forecasters had initially waved off the supply constraints as temporary kinks of the pandemic recovery, concern is growing that some of the backlogs will take a long time to clear.

The timeline for resolving the microchip shortage, for one, “keeps getting pushed further and further,” Porter notes.

Click to play video: 'Your Money: What falling lumber prices could mean for your next home reno project' Your Money: What falling lumber prices could mean for your next home reno project
Your Money: What falling lumber prices could mean for your next home reno project – Jun 17, 2021

And in addition to higher costs for material, goods and shipping, many businesses are also butting up against another shortage: workers.

In Canada small businesses are having a tough time recruiting part-time workers especially, says Dan Kelly, president and CEO of the Canadian Federation of Independent Business (CFIB).

It’s a problem Kelly blames on federal COVID-19 income supports like the Canada Recovery Benefit (CRB).

Ottawa has already started scaling back the level of benefits provided, but CRB still pays $300 a week pre-tax. That is twice as much the $150 someone would earn working 10 hours a week at $15 an hour, Kelly notes. And while being available for work is a requirement for receiving CRB, the rule is “poorly enforced,” according to Kelly.

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“For many part-time workers, they are actually better off while remaining on benefits than they would be going back into the workforce,” he says.

But workers may also be concerned about whether it’s safe to return to work, especially in frontline jobs, economist Mikal Skuterud of the University of Waterloo, previously told Global News.

A lack of child care options may also hinder some parents’ ability to return to work, Skuterud says. The pandemic has forced some daycare centres out of business, while many summer camps operators decided to stay closed in 2021.

In the U.S., historic labour shortages have propelled wage growth for low-income workers, as businesses in the retail, restaurant and tourism industry compete to attract new staff. In Canada, there is still little hard data pointing to upward pressure on salaries, although anecdotal accounts of employers bidding up wages abound.

Click to play video: 'Labour shortage forces businesses to operate at lower capacity in Edmonton' Labour shortage forces businesses to operate at lower capacity in Edmonton
Labour shortage forces businesses to operate at lower capacity in Edmonton – Jul 20, 2021

To foot the bill for higher wages without raising prices for customers, businesses generally need to increase productivity — that is, raising output per worker, Skuterud told Global News. Without a productivity boost, though, higher wages tend to translate into inflation rather than lasting gains for workers, he added.

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“If we actually see wage increases begin to accelerate in quite a broad-based fashion, that’s how (inflation) could become a little bit more a bit of an issue that lasts longer,” Porter says.

Another factor that might be contributing to the price increases is consumers’ unusual willingness to tolerate higher prices, Ambler says.

Many Canadians are likely not only aching to spend more but also able to do so after saving up during months of low-key living in the pandemic, he notes.

“Demand is is so pent up that people are going to be happy to be able to go out and spend, even if things are more expensive,” he says.

Ultimately, what could really turn a temporary stretch of inflation into a longer-lasting phenomenon is consumers, workers and businesses believing that prices will continue to rise at a faster clip, Porter says.

“We’ve been in a two per cent inflation world for about 30 years now,” he says. But a collective mind shift can become an “almost become a self-fulfilling prophecy.”

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