Inflation is often misunderstood as a force that makes everything more expensive. In reality, it’s a term economists use to describe a general increase in prices across the economy.
Inflation does not mean every price is rising. Some goods become more expensive, some become cheaper and others barely change. Inflation measures the overall direction of prices.
In 2022, inflation in Canada reached eight per cent, its highest level in decades. By February, it had fallen to 1.8 per cent before rising again to 3.2 per cent in May and then easing to 2.7 per cent in June.
To understand these swings in inflation, it helps to understand how it’s measured and what forces push individual prices up or down.
Inflation is An Average
In Canada, inflation is measured using the consumer price index (CPI), which tracks monthly price changes for hundreds of goods and services. The CPI is a weighted average, meaning some categories have a larger influence on the overall measure than others.
The largest components are housing, food and energy. Housing accounts for about 30 per cent of the index, food about 17 per cent and energy roughly seven per cent. Energy is a relatively small component, but fuel prices affect the cost of many other goods and services.
Prices generally rise for one of two reasons. First, demand for a product can exceed supply, pushing consumers to compete for limited goods. Second, businesses can face higher costs for labour, energy, transportation or materials and pass those increases on to consumers.
The reverse can also happen. When supply grows faster than demand, prices can decline. And when production costs fall, businesses facing competition may pass those savings on to consumers.
These forces help explain why some parts of the economy experience strong inflation while others remain stable.
Housing Drove Much of the Inflation Surge
Housing was one of the biggest sources of inflationary pressure in Canada because demand increased faster than supply.
Following the COVID-19 pandemic, unusually low interest rates allowed many households to take out larger mortgages and bid up home prices. At the same time, rapid population growth driven by record levels of immigration increased demand for housing.
Supply could not keep pace, causing both rents and home prices to surge. More recently, this trend has started to reverse. Changes to immigration policy have slowed population growth, while higher interest rates have reduced the size of mortgages many buyers can qualify for.
The result has been falling home prices and rents in some parts of the country.
Food Prices Ease as Costs Increased
While population growth increased demand for groceries, supply challenges have been a major factor behind rising food prices.
Russia’s invasion of Ukraine in 2022 increased global energy costs, making food production, transportation and storage more expensive. It also disrupted fertilizer markets, as Russia had been a major global supplier. These higher costs were eventually passed on to consumers through higher food prices.
Meat prices show how these pressures can accumulate. Increased production costs, combined with a decline in cattle stocks, have caused beef prices to rise. Since the pandemic, the price of beef top sirloin has roughly doubled.
As beef became more expensive, some consumers shifted toward chicken and pork, increasing demand for those products. Prices for chicken breast and pork loin have both increased by about 22.5 per cent as a result.
Other foods have also been affected by weather conditions, labour costs and transportation expenses. Lettuce, for example, is often imported from the United States and Mexico, making it vulnerable to supply disruptions and higher shipping costs.
But not all grocery prices move in the same direction. Some, like cucumbers and strawberries, can vary widely in price depending on growing conditions and whether Canadian-grown supplies are available. Other products, such as canned tuna, have changed very little over time.
Energy Prices Can Quickly Change Inflation
Energy is one of the most volatile parts of inflation because prices are shaped largely by global events. Changes in global oil markets affect gasoline and diesel prices, increasing costs for Canadian families and businesses.
Fuel is an important input for transportation and production, so changes in energy prices can spread throughout the economy. When fuel costs rise, businesses may face higher expenses for moving goods and providing services, and some businesses have started adding fuel surcharges to customer orders.
Global events can quickly disrupt energy markets. Russia’s invasion of Ukraine in 2022 upended global energy networks. More recently, the United States’ war with Iran has caused another oil price shock.
When energy prices rise, they put upward pressure on the CPI. When they fall, they can help bring average inflation down. But global energy markets are largely outside the control of Canadian households and policymakers.
What Goes Up Doesn’t Always Come Down
Unlike energy prices, which are largely driven by global markets, housing and food are areas where Canadian policies can influence supply over time.
Canada faces a significant shortage of affordable housing. Reducing red tape, lowering development charges, adjusting tax policies and subsidizing new construction could help increase housing supply over the coming decade.
A significant increase in both market and public housing will be needed to bring shelter costs back to more affordable levels.
A similar challenge exists with food. Grocery prices have risen faster than the overall inflation rate for 16 consecutive months and in 50 of the past 55 months. Increasing domestic food production could help ease some of these pressures.
Recent federal tax changes and funding announcements aimed at expanding greenhouse production are intended to strengthen Canada’s food supply chain, but it’s too early to know how effective they will be.
Even if these efforts succeed, lower inflation does not mean prices will return to where they were before. Inflation measures the average change in prices over time, not which specific prices are rising or falling.
Each month, some goods become cheaper while others become more expensive. The CPI is an average across all those price changes. In most cases, the price increases for some goods outweigh the price cuts for others, which is why the overall average goes up — sometimes by a large amount and sometimes by just a small amount.
Assistant Professor of Economics, McMaster University. | This article is republished from The Conversation under a Creative Commons license.
