Economy

Following a couple of peaks in inflation—up to 12.5 per cent in 1981—inflation in Canada has generally been below 3 per cent since 1992. Inflation is measured by keeping track of the cost of a basket of goods and services used by a typical consumer. With an inflation rate of 2.37 per cent in 2008, a basket of goods that cost $100 in 2007 would cost $102.37 in 2008. Ultimately, inflation erodes the purchasing power of consumers; that is, it reduces the quantity of goods that can be purchased with a given amount of money.

Hyperinflation—or “out of control” inflation—can lead to the breakdown of a country’s monetary system and to social and political unrest.

Deflation—the simultaneous sustained fall in prices for a broad range of goods and services—is also harmful to economic security. Deflation usually occurs during a recession and hurts production and employment.

We award an “A” grade to inflation that falls within the Bank of Canada’s inflation-control target range, which is between 1 and 3 per cent. Inflation outside this target range (either above or below) is awarded a lower grade. The further away from the target range, the lower the grade. Countries with inflation between 0 and 1 per cent or between 3 and 4 per cent earn a “B” grade. We grade inflation between 0 and 1 per cent to be a “danger zone” because it may signal that a country is slipping into deflation. The one exception is when inflation between 0 and 1 per cent is due to currency appreciation or strong productivity growth—these countries are awarded an “A” grade. Inflation between 0 and −2 per cent (deflation) or between 4 and 6 per cent is given a “C” grade. The lowest grade, “D,” is given if inflation is above 6 per cent or if prices are falling by more than 2 per cent, an indication of more severe deflation.

Canada fared better on the inflation front in 2008 than most of its peers. Canada is one of only six peer countries to receive an “A” grade for inflation performance in 2008. Rising energy and commodity prices pushed inflation in seven countries over 3 per cent—the upper band of the Bank of Canada’s target zone—and over 4 per cent in four countries. Ireland already had an inflation rate of over 4 per cent in 2007. The one percentage point reduction in the federal goods and services tax (GST), the strong Canadian dollar, sluggish economic growth, and easing home prices all helped to keep Canada’s inflation in check.

High inflation reflects a volatile economy in which money does not hold its value for long. Workers need higher wages to cover rising costs, and are not inclined to save because the cost of goods and services is expected to be even higher in the future. Producers in turn may raise selling prices to cover cost increases, and cut back production to control their costs (resulting in layoffs).

Citizens on fixed incomes—like many pensioners—are particularly hard hit by high inflation. While the wealthy can usually protect themselves against inflation by investing in assets—such as stocks, bonds, or property—that increase in value during periods of inflation, those on fixed incomes find the value of their income eroding. If the inflation rate is 6 per cent, someone on a fixed-income pension will not receive the 6 per cent income increase to compensate, and so that person’s purchasing power is reduced. This leads to an increase in income inequality, or a growing gap between the “haves” and the “have-nots.”

Hyperinflation—“out of control” inflation—can lead to the breakdown of a country’s monetary system. Some notable cases of hyperinflation include Germany in 1923, when prices doubled every two days, and Yugoslavia in 1993, when prices doubled every 16 hours. Zimbabwe now holds the world record for highest inflation; inflation recently surged to an estimated 165,000 per cent. Canada has never experienced hyperinflation.

Price declines due to productivity gains can be beneficial. But deflation is something entirely different and generally considered to be bad for the economy. Deflation is the simultaneous sustained fall in prices for a broad range of goods and services. A country will always have some goods or services with falling prices, like the decline in the cost of computers or cell phones. But deflation causes increases in real interest rates, triggering loan defaults. Consumers also postpone purchasing goods and services on the bet they will be cheaper tomorrow. When deflation occurs, businesses can no longer sell their products, leading them to cut back on production and employment. This leads to even lower demand for goods and, in turn, to lower prices.

Historical experience has shown that once deflation is set in motion, it is extremely difficult to stop, as Japan has found out. Japan was in the grip of deflation for over a decade beginning in the early 1990s. This hampered all government attempts to revive the economy. Although the Japanese economy has since recovered somewhat, prices are still low, and the government has not yet declared an end to deflation.

Inflation was a headline issue in Canada in the 1970s and early 1980s. The first spike was in 1974 when inflation rose sharply to 11 per cent, mainly as a result of the dramatic increase in oil prices, what some have called “oil price shock.”  Prices for items such as housing and food followed suit. In response to the higher cost of living, unions went on strike to increase wages. World commodity prices also rose sharply. The Canadian government responded by instituting wage and price controls, which curbed inflationary pressures for several years. These controls were phased out in 1978.

The second spike was in 1981, when inflation hit 12.5 per cent. Tighter monetary policy cut inflation by half within two years. Annual inflation did not rise above 6 per cent between 1983 and 1991. And since 1992, the Bank of Canada’s subsequent inflation-targeted monetary policy has generally kept inflation below 3 per cent.

Except for Switzerland and Germany, all peer countries received a “D” grade in the 1970s because of average inflation rates above 6 per cent. Dramatic inflation declines in the 1980s in several countries earned some countries an “A” grade. In the 1990s, most countries, including Canada, had tamed inflationary pressures and received “A” grades.

Use the drop-down menu to compare the change in Canada's inflation rate with that of its peers.

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Income Per Capita	Unemployment Rate
GDP Growth	Employment Growth
Labour Productivity Growth	Inward FDI Performance Index
Inflation	Outward FDI Performance Index