The basics of inflation

Michael Lawrence, CFP®, CIM® - Sr. Advising Specialist

What is inflation?

Inflation is the price increase of a basket of goods and services over a year. It's tracked by the Consumer Price Index (CPI) and the basket includes eight components:

• Food
• Shelter
• Household operations, furnishings and equipment
• Clothing and footwear
• Transportation
• Health and personal care
• Recreation, education and reading Alcoholic beverages, tobacco products and recreational cannabis

Depending on how much a given individual consumes in each component, the impact that inflation has on an individual’s life will differ. For instance, those that work from home may be less impacted by rising gas prices but might spend more on furnishing their home office.

How does the Bank of Canada attempt to curb inflation?

The Bank of Canada (BoC) targets inflation at 2.0% annually and it tends to float between 1.0% and 3.0%. See the Consumer Price Index chart below. Inflation is currently higher than the control range, which is why the BoC is increasing interest rates. In theory, this should slow economic activity because higher interest rates mean that businesses and individuals will borrow less and prioritize debt repayments. They will also prioritize increased savings as the higher interest rates mean better returns on products such as GICs and savings accounts. With reduced consumption, supply chain constraints should ease and inflation should decrease.

Currently, supply chain constraints are a major factor contributing to rising prices. Using fuel as an example, higher fuel prices mean higher costs to produce and transport goods. These higher input costs are typically transferred to the end consumer in the form of higher prices. It’s one of the reasons your grocery bill has gone up month over month for seemingly the same or less food. This is typically where the average Canadian “sees” inflation, however it is present in many aspects of the economy including energy costs, used cars, contractor services, home appliances and home rental rates.

It is not all gloom and doom

We expect inflation to return to the target range, as it always has. However, it is likely that higher prices at the pump and at the checkout will be here for a while. Prices tend to be “sticky,” meaning they go up quickly but “stick” and take longer to fall. Prepare yourself for increasing costs and higher interest rates by considering the following actions: review your budget, save more by cutting back on discretionary spending and ask your Edward Jones advisor to review your financial strategy for your short- and long-term goals.