Wednesday, February 13, 2013

Why is Canada's inflation rate lower than in the U.S.?

February 13, 2013

Why is Canada?s inflation rate lower than in the U.S.?


Chief Economist, CanaData

The year-over-year change in Canada?s All Items Consumer Price Index (CPI) in December was the same as in November, +0.8%, according to Statistics Canada.

The latest inflation rate (+0.8%) was the lowest since October 2009 (+0.1%). At that time, the recession was taking a bite out of all economic activity. The general price level even declined for four months, from June 2009 through September 2009.

The ?core? inflation rate, which omits eight sub-items (mainly in food and energy) that usually display highly volatile price changes, was also restrained at only +1.1%. That was its lowest increase since February 2011.

The most recent change in overall prices was a far cry from the +3.7% that was recorded in May 2011. Since that most recent peak, the inflation rate has been mostly moderating.

For both the overall inflation rate and the ?core?, Canada?s December figures were almost a full percentage point below what the U.S. experienced. The all-items inflation rate south of the border in the latest month was +1.7% and excluding food and energy (i.e., the U.S. definition of ?core?), it was +1.9%.

Neither food nor energy is exerting much of an influence on prices at this time. Canada?s food sub-index was +1.5% year-over-year in December, while energy was -0.5%. The critical petrol price at the pump in Canada was +1.0%.

In the U.S., the comparable figures were +1.8% for food, +0.5% for energy and +1.7% for gasoline.

The lower rate of inflation in Canada versus the U.S. is a little surprising on several counts. For starters, Canada is closer to full capacity than the U.S. Our total industry utilization rate in the third quarter of last year was 80.9%.

For America, the Federal Reserve has calculated that total industry was operating at 78.8% of capacity in December.

(In Canada, Statistics Canada publishes capacity utilization rates quarterly. The U.S. figure is estimated monthly by the Federal Reserve. By the way, Canada?s manufacturing usage rate in Q3 2012 was 81.7%. In the U.S., it was 77.4% in December.)

With respect to labour availability ? which has an effect on wages and salaries and therefore prices over the longer-term ? Canada?s unemployment rate in December was 7.1% compared with the U.S. figure of 7.8%.

The U.S. unemployment rate is set for further rapid improvement, however. The latest weekly initial jobless claims level (330,000) south of the border was the lowest in five years. During the recession, the number of first-time U.S. unemployment insurance seekers was routinely over 500,000.

Working in the opposite direction ? i.e., to make U.S. inflation higher than in Canada ? has been monetary policy. While both the Federal Reserve and the Bank of Canada (BOC) have been deploying stimulatory monetary tools, the former has been more aggressive than the latter.

The Fed?s interest rate policy is contributing more to inflation. The current federal funds rate stands at nearly zero per cent (between 0.00% and 0.25%), while the BOC?s ?overnight rate? is 1.00%.

Plus the Fed has adopted several sessions of quantitative easing, otherwise known as printing money, including its most recent strategy of purchasing $40 billion per month in mortgage-backed securities

What?s the longer-term outlook for the inflation rate? Aggressive interest rate policies at this time, combined with low inflation are yielding interesting results.

It?s possible to derive long-term expectations about price movements based the difference between inflation-indexed bonds and ?normal? bonds. For each product to be competitive in investment markets, the difference in yields must be the consensus assessment of the inflation outlook.

For inflation-indexed bonds, the principal is automatically adjusted for the actual inflation rate each year. U.S. inflation-indexed Treasury Bills with maturities of 10 years are carrying negative interest rates. The current 10-year yield is -0.65%.

Since the rate on ?nominal? interest-bearing 10-year bonds is 1.87%, the forecast for average annual inflation over the next decade is 2.52% (i.e., the result from subtracting the two yields).

The 1.87% return for ?nominal? 10-year treasury yields is itself quite low. Consider that in Europe, the countries that have descended into the most financial trouble have been those with long-term bond yields approaching or exceeding 7.00% per year.

The U.S. has maintained such a low financing charge even in the face of one debt downgrade. In a welcome move, the Republican-controlled House of Representatives has voted to temporarily allow the Treasury Department to spend beyond its debt ceiling of $16.4 trillion.

A three-month reprieve is in effect, moving the financing ?cap? debate from mid-February to mid-May.

Hopefully, by that time, there will be progress on other budgetary measures, such as spending cuts, that will forestall a new crisis and the possibility of a second debt downgrade.

For more articles by Alex Carrick on the Canadian and U.S. economies, please see his market insights. Mr. Carrick also has an economics blog. His lifestyle blog is at

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