Inflation in Canada

Introduction

High inflation can be caused by both rising demands end falling supplies. For the appropriate

conduct of monetary policy, it is crucial to know by which of the two the high inflation was

caused.

We use two decompositions to calculate Canada’s consumer price index (CPI) to find

the causes of inflation. Firstly, we start by making an estimate of contribution of individual

products to the inflation of Canada. Secondly, we make an adaptation to the approach of

Shapiro (2022a) to find the importance of shocks within the supply and demand.

Accordingly, to a simple Laspeyres price index, inflation is defined by the average change in

prices of items, weighted by base-period outlay shares. Unfortunately, Canada CPI is far

more complex: a linked index with episodic basket re-weighting. Using CPI, we only find

few of the items responsible for high inflation.

Not a typical aspect of recent inflation is the contribution the large factor of owned

accommodation. In a specific term: homeowners’ replacement cost. Statistics Canada has

estimated this cost to be 1.5% annually. There is not a specific best way to measure the cost

for ownership of a home. In the period of July 2021 till April 2022 this factor alone

contributed on average over 0.7% to inflation measured with CPI.

The rise of energy prices would be a good explanation for rapid rises in inflation. So,

we started analysing the potential of high energy prices to account for inflation. We also went

with a new approach and a different set of data to specify demand- in supply-based inflation.

In order to characterise weather items were sensitive to changes in oil prices, we estimated

their relationship using statistics of year over year changes in oil prices and prices of certain

items. The item homeowners’ replacement turned out to be one of the sensitive to oil price

items. According to our estimation of July 2022, items that are sensitive to oil prices have

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contributed 3.6%. To the total 6% increase in non-energy consumer prices. This results in

being almost 60% of Canada’s non-energy rate of inflation in July from items that have

shown to statistically stay close to the change in oil prices. This result leads to a higher

energy price and can explain the acceleration in the inflation in Canada.

To specify the contribution that demand- and supply factors have made, we needed up

to date data on prices and quantities. This is not included in CPI but is in a not-mainstream

database. With the use of a personal consumption expenditure (PCE) deflator we constructed

a measure of inflation. The publicly available statistics data source we used for this is:

Canada dataset detailed household final consumption expenditure (DHFCE, table 36-10-

0124-01), which provided us with a detailed dis aggregation of expenditures detailing to

almost 100 separate items.

After a long period of high inflation, the monetary policy is strengthening. in order to

gain knowledge two counter inflation in Canada with monetary policy, PCE inflation must be

further decomposed into more goods and services, levels of persistence of prices and

sensitivity to interest rates.

Jop Mourits (8922810)