Canadian economists are scrambling for a reliable measure to track underlying inflation as large and frequent revisions have dented the credibility of a key Bank of Canada yardstick, even as the central bank said it was sticking with its core measures.
Canada’s central bank has three preferred measures of core inflation — CPI-common, CPI-median and CPI-trim. CPI-common, once touted as the best gauge of the economy’s performance, has been subject to repeated revisions since the start of this year.
Those same revisions show that price moves originally identified as transitory turned out not to be transitory at all, highlighting the measure’s ineffectiveness when prices rise rapidly and calling into question its value, said analysts.
“I believe the steep upward revisions to common have rendered it useless as a policy guide,” said Doug Porter, chief economist at BMO Capital Markets. “It missed the inflation boat at the start of the year and sent an entirely misleading signal to policymakers.”
To estimate core inflation, CPI-common measures all the components of the consumer price index that are moving together and separates out those that appear to be fluctuating due to sector-specific events. By contrast, both CPI-trim and CPI-median operate by filtering out extreme price movements.
CPI-common was almost never revised when inflation was close to the Bank of Canada’s two per cent target. But with prices rising faster than they have in decades, it is now being revised and revised again each month.
These revisions are happening because the statistical model is picking up more co-movement in price, so the entire series has to be re-calculated each month, said Statistics Canada.
“Essentially, this means that more CPI goods and services are moving in common, or that inflation is more broad-based now than it has been in the past,” the agency said in a statement.
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Despite the revisions, the Bank of Canada will “continue to look at all of our core inflation measures” as it works to get inflation back to target, said spokesman Alex Paterson.
“One reason why the Bank uses three different core measures is to make sure we’re considering different price perspectives when judging the underlying trend of inflationary pressure,” he said in an email.
Governor Tiff Macklem is due to give a speech on the current economic situation on Thursday, with a news conference to follow.
The three core measures were introduced in 2017 to replace CPIX, which is the headline inflation figure excluding eight of the most volatile components in a basket of commonly used items.
A 2019 report by Bank of Canada analysts, which evaluated the performance of seven core measures from 1992 to 2018, noted CPI-common was the “least volatile” and seemed “less prone to revisions and sector-specific shocks.”
But it was developed at a time when inflation rarely drifted out of the Bank of Canada’s one-to-three per cent control range. Inflation has now been above three per cent for 17 months and was at 7.0 per cent in August.
With CPI-common’s usefulness now in question, and the odds of a recession rising, the central bank should be taking a hard look at how it tracks core inflation, said analysts.
“The Bank’s challenge is walking the extremely fine line between tightening enough to get inflation back to target while not tightening so much that it causes a major recession,” said Stephen Brown, senior Canada economist at Capital Economics.
Some analysts say the Bank of Canada should return to CPIX or simply track how many index components are rising more quickly than the two per cent target.
Others say the best gauge is inflation excluding energy and food, because it is easy to explain and is similar to how the United States measures underlying price pressures.
“The BoC needs to address how it has over-complicated core inflation and what measures it follows,” Derek Holt, head of capital markets economics at Scotiabank, said in a note.