September 15, 2012 - MLI's Brian Lee Crowley discusses inflation and why we should care about it in his latest column for the Ottawa Citizen, Calgary Herald, and Vancouver Sun. Column below:

Why we should worry about inflation

By Brian Lee Crowley, Ottawa Citizen, September 15, 2012

Is inflation back?

Maybe not today, but perhaps soon. Countries with massive debts are always tempted to debase their currency in order to squeeze the value of that debt. Many Americans fear that the Federal Reserve's so-called "quantitative easing" is merely code for flooding the economy with money, which will unleash inflation.

You could make the case that a lot of today's conflict among the eurozone countries is over inflation: Germans and other northern Europeans, who work hard, run a tight budgetary policy and hate inflation, fear that heavily-indebted southern Europeans will succeed in debasing that currency to ease their pain.

Here in Canada the C.D. Howe Institute has just published a paper arguing that we have been understating the rate of inflation at least since 2009, when house prices started a strong rise. This they put down chiefly to StatsCan's inflation measurement basing housing costs on the costs associated with owning a home, not on the rising costs of the house itself.

By C.D. Howe's suggested revised measure, inflation may have been1 percent higher than we thought in recent years. That's likely overstated, but let's take it at face value just to see what it means if true.

You might think that an extra 1 percent doesn't sound like much. But you might want to reconsider that view.

Unfortunately Canadians have been lulled into a false sense of security by the policy of the Bank of Canada that "targets" an inflation rate of 2 percent. That sounds like a low rate, but even low-sounding rates over long periods add up to a lot.

Consider that someone getting a fixed-income pension would see their purchasing power eroded by over 30 per cent over the course of a 20 year retirement at an inflation rate of 2 per cent. See how you feel getting a third less for your dollar when you are not in a position to increase your income.

Now add a one percentage point rise to that inflation rate. What happens to the value of your pension over 20 years? It would fall by nearly half (45 percent). Even at an inflation rate of 1 percent the value of your pension falls by a fifth.

Lest you think, by the way, that inflation is simply the human condition, a chart showing inflation for the British pound since 1750 shows that minimal inflation is actually the historical norm, and it is only in the modern era that we have become inured to high inflation. Granted we have seen off the double-digit rates of the 1970s and 1980s, but that doesn't mean that 2 percent (the target since the Mulroney days) is "low inflation." As economist David Laidler has shown, the effect of the first 15 years of the pursuit of that policy was the value of the dollar fell by a quarter.

Interestingly the 2 percent target was originally sold as a mere down payment on progress toward "price stability," defined as inflation of "clearly less than 2 per cent." We were supposed to get that by 1995. We're still waiting.

Should we care about higher inflation? Absolutely. Politicians are drawn to inflation for a number of reasons, and that puts them in a conflict of interest with the average person who depends desperately on the value of his or her money remaining stable. That's why we have evolved a system of central banks that are independent of politicians, and whose job is to protect the value of the currency—up to a point.

As I've already pointed out, 2 percent inflation, which has long been the target, is not low inflation at all. And in the world's desperation to re-start economic growth, both politicians and central bankers are going to be deeply tempted to allow more inflation.

But we should never forget that inflation is a radically anti-poor policy and that the greatest beneficiaries of the defeat of the rampant inflation of a lot of the postwar period were people on low and fixed incomes. If you doubt this proposition, there is a celebrated 2000 paper by Aart Kraay and David Dollar who show, among other things, that low inflation is "super-pro-poor" because high inflation is more harmful to the poor than to the economy overall.

If I were a Canadian politician, I'd be less tempted to inflate away my debts as I thought about the huge Boomer generation moving into retirement, most of whom — with the exception of those lucky few with gold-plated public sector inflation-adjusted pension plans — will be facing fixed incomes and a stiff implied loss of purchasing power just under current policies, let alone higher inflation in future. Never forget that pensioners vote, massively. Boomers have a way of getting what they want, and low inflation will be ever higher on their list.

Brian Lee Crowley is the Managing Director of the Macdonald-Laurier Institute, an independent non-partisan public policy think tank in Ottawa: @MLInstitute

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