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Trying to make sense of inflation? So is everybody else

Markets zig-zag as everyone waits to see how seriously the Fed takes new U.S. data on rising prices

An inflated hot-air balloon in the shape of a cow.

An inflated hot-air balloon in the shape of a cow rises in the air above the western Swiss village of Chateau d'Oex in this file photo. The price of beef, and just about everything else, is going up.

Photo: Reuters / Dominique Favre


For a lot of smart people, the way inflation works is no easier to understand than COVID-19.

And when we hear, as we did yesterday, that the person who is supposed to be one of the world's biggest inflation experts did not see the current round of price rises coming even after the pandemic hit, that may bolster our egos. But it isn't entirely reassuring that the world's economy is in safe hands.

With predictions that the latest U.S. inflation figures, out later this morning, could hit a shocking 7.1 per cent — a level unheard of in younger people's lifetimes — it would be nice to know there is nothing to worry about. When the data was released Wednesday morning, it revealed prices were up 7.0 per cent, a new 40 year high.

One U.S financial commentary offered up a handy tongue-in-cheek guide on how to panic about inflation (new window), which may not be entirely reassuring either. 

Chased by a bear?

But as with any threat, from being chased by a bear to fighting off a new pandemic variant, understanding a bit more about what's going on doesn't necessarily solve the problem. It can, however, help you cope.

The fact that the world's most influential central banker, Federal Reserve chair Jerome Powell, did not see the current extraordinary levels of inflation in his crystal ball is an important bit of information. The fact was driven home at Tuesday's Senate hearing confirming his reappointment, where Powell was asked how he could avoid a similar surprise in the future.

This is a unique situation, he replied. We don't have 10 pandemics to look back on and say these are the common features when the global economy shuts down to deal with a global pandemic. It was all just new.

If Powell and his highly paid experts didn't see it coming, don't kick yourself if you didn't, either.

An American gas station with prices on board.Enlarge image (new window)

At Tuesday's Senate hearing to confirm his reappointment as Federal Reserve chair, Jerome Powell was asked about the rising price of gas that, which is currently more tha $5 US a gallon. 'This is a unique situation,' he told the senators, referring to the pandemic.

Photo: Reuters / Mike Blake

It is also a reminder of why markets have been zigging and zagging on each little bit of new information, not only about what's coming next, but exactly what Powell and the Federal Reserve are going to do about it. No one can be sure.

A conversation I had over the recent holiday with some bright young people served as a reminder about how many of the concepts of inflation can be unfamiliar for them, at least partly because they've never really had to think about it in their own lifetimes.

Even the word inflation can be confusing. For an older generation that watched it happen in the 1970s and 80s, inflation very likely has an obvious intuitive meaning.

Price of houses not included

Many Canadians have a sense of what's happening after watching the price of houses grow. As an asset and not a consumer good, however, they're not directly included in the inflation figure.

The action of inflating, as in blowing up a balloon, may offer a wrong impression.

Inflation is in some ways more like letting the air out of a balloon: the savings in your bank account decline in value. In other words, one measure of inflation is that if you, as a Canadian, put a hundred dollars in an envelope last January and you pulled it out to spend it now, it would only buy 95 dollars worth of the stuff you could have bought a year ago.

In other words, we are not talking about money inflating like a balloon — prices are. During inflation, the average price of most goods goes up, some a little more and some a little less, because the value of money is falling.

WATCH | What's causing inflation? 

Ways of measuring inflation can also be confusing.

The number that people will be talking about on Wednesday will be the U.S. consumer price index, or CPI. It measures how much it cost last December to buy a certain set of consumer products and services and compares that to how much it cost to buy the same goods and services last month.

Sometimes that's called the headline inflation, or headline CPI, because it is the number you'll hear on the news, perhaps because it's more dramatic, but it is also the actual impact of rising prices on household costs in that particular month.

But central banks, including the Bank of Canada, are more concerned about a different number altogether called core inflation, which is essentially a measure of inflation that takes out prices that are all over the map, such as food prices in winter and gasoline prices almost anytime. 

Don't get smug

It can also be confusing that despite a very integrated North American economy, inflation always seemed be a lot lower in Canada than in the United States. But just when Canadians might have begun feeling smug, Canadian bank economists are pointing out that a large portion of the difference is a discrepancy in the way the two figures are calculated, including the fact Statistics Canada left out the rising prices of used cars (new window).

Another important concept for the understanding of inflation is real versus nominal.

At Tuesday's confirmation hearing, following optimistic comments by Powell about how wages were on the way up, U.S. Sen. Pat Toomey asked a question that helped explain why a dollar value, or nominal increase in income can only be seen in light of the real increase after inflation has been subtracted.

Powell in conference.

Powell says he hopes supply chains will work themselves out, but he can only wait so long before raising rates. Otherwise, inflationary expectation will become entrenched in the economy.

Photo: Reuters / Kevin Dietsch

There have been some comments about wage gains, said Toomey. But wage gains that are more than wiped out by price increases do not leave a family better off.

In my holiday conversation on inflation one of the young people I was talking to scoffed at the idea of their bosses ever offering a five per cent wage increase, because in their experience wages only went up by one or two percent. That is what's called inflation expectations.

Powell knows that he is in a race with those tame expectations, and they're not going to last if high inflation persists.

Asked about getting inflation under control with higher interest rates, Powell repeatedly pointed out that while rate hikes might control borrowing and thus the demand for goods, the main current drivers of inflation are problems with global supply, something raising interest rates won't fix. 

My expectation is that we will see some relief on the supply side as the year goes on, said Powell. If that doesn't happen and we see inflation becoming even more persistent...then I think the risk of it becoming entrenched in the psychology of businesses and households and people, I think that increases.

And if supply chains don't fix themselves soon, rising inflationary expectations and entrenched inflation may become the bigger menace.

Follow Don on Twitter @don_pittis (new window)


Don Pittis (new window) · CBC News · Business columnist

Don Pittis was a forest firefighter, and a ranger in Canada's High Arctic islands. After moving into journalism, he was principal business reporter for Radio Television Hong Kong before the handover to China. He has produced and reported for the CBC in Saskatchewan and Toronto and the BBC in London. He is currently senior producer at CBC's business unit.