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Prices may go up, but here’s why Stephen Poloz doesn’t care too much

By on May 13, 2021 0

Kevin Carmichael: Poloz believes the world is just finding its way to a new balance between supply and demand

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Few Canadians have devoted more effort to fighting inflation than Stephen Poloz. He conducted much of the research that persuaded his Bank of Canada bosses to adopt an inflation target in the early 1990s and use the Consumer Price Index to guide their thinking on the way of setting interest rates. A few decades later, he took over the central bank, taking over the political regime he helped create as a young researcher.

Poloz’s tenure as governor was reserved following the Great Recession and the early months of the COVID-19 crisis. The year-over-year change in the CPI has averaged 1.6 percent per month over his seven years at the helm, slower than the target of around 2 percent. This shows that he did not have a heavy foot on the accelerator. Some economists even think he could have been more aggressive. The record suggests that Poloz preferred to err in keeping inflation contained.

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End of 2019, Poloz observed that “the risk of a spike in inflation remains low, but still appears to be higher than it has been in the past 30 years”. The remark stood out because few people were talking about inflation at the time. The CPI remained stable and the Bank of Canada kept its cool when many central banks cut interest rates earlier in the year. The prices were under control.

Now people want to talk about inflation. It’s hard to have a conversation without someone bringing up the cost of wood. Stock markets plunged on May 12 after the United States government released data showing its CPI rose 4.2% in April from a year earlier, the most since 2008 and more than what a lot of Wall Street had anticipated. The report reinforced arguments that the extraordinary stimulus central banks and governments injected into their countries to offset the effects of the pandemic ultimately caused economies to overheat.

Is Poloz worried? Not really. His 2019 comments were based on a change in political attitude that he said could lead to a structural shift in public spending and public debt. But this is a longer term trend. He sees the current inflation surge as transitory.

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“This is something we need to take seriously,” Poloz, who is now a special adviser at law firm Osler, Hoskin and Harcourt LLP, told Larysa Harapyn of the Financial Post this week. “But right now, most of the signals come from the commodities markets, which are naturally on the rise.”

The Bank of Canada’s monthly commodity price index was 121% higher in April than a year earlier. This increase is exaggerated by the calculations generally used to track price changes. April 2020 aligned with the worst of the COVID-19 crisis, when prices collapsed, so current readings are skewed by base effects. Yet anecdotal evidence of supply shortages for vital inputs is real. The central bank‘s commodity price measure climbed 23 percent this year through April.

“I don’t want inflation. I don’t want inflation. I think inflation will come. It has to come, ”said Mark Barrenechea, managing director of Open Text Corp., a software developer based in Waterloo, Ont., In an interview on May 7. the costs, the lack of petrochemicals outside of Texas, the skyrocketing lumber costs. I think inflation will come in. “

To some extent, central banks rely on it. A year ago, the Bank of Canada was worried about deflation. That’s why he lowered his benchmark interest rate to an all-time high and started using his unique power to create money to buy bonds. The aim was to bring inflation down to 2%.

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Financial markets fear central banks have done too much. But Poloz doesn’t think so. He believes the world is just finding its way to a new balance between supply and demand. The prices of some goods and services could stabilize at a higher level than before the pandemic, but the rapid increases that businesses currently face will ease.

“Many industries have gone out of business, allowed stocks to run out during the pandemic and now we are getting excess demand,” Poloz said. “But on the other side of any expansion in demand in the commodity sector, you get expansion in supply. So, I suspect this is a very temporary phenomenon. “

The industrial capacity utilization rate, a measure of the gap between actual production and what the industry could produce if it maximized its facilities, dived at 71.4% in the second quarter of 2020, up from about 81% in the first quarter, according to Statistics Canada. This figure had only risen to around 79% by the end of the year, the most recent data available.

“In terms of the economy, we know there is excess capacity, so we know we have room to grow before we actually have fundamental inflationary pressures,” Poloz said.

The path of inflation will ultimately be determined by Barrenechea and thousands of other leaders who will now decide whether to absorb rising input costs or raise their own prices. Barrenechea said tech companies tend to do well during times of inflation because their input costs are relatively low, so higher prices mean windfall profits.

Open Text has not raised its prices, but, like central banks, its executives are watching the CPI.

“When inflation occurs, it will actually help income,” Barrenechea said. “We will also increase our prices. We won’t be leading this, but we will be a quick follower. “

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