There’s no question that inflation this year has been a shock. Researchers at the Montreal Economic Institute argue that it’s even more shocking than the official numbers have been telling us.
A new paper from MEI director of research Valentin Petkantchin and senior economist Nathalie Elgrably-Lévy argues that the year-over-year change in the consumer price index, or CPI – the figure we commonly call the inflation rate, which sat at 7.6 per cent in July – has routinely understated the pace of consumer inflation this year.
They calculated that based on a more timely “speedometer” for prices, the annualized inflation pace exceeded 10 per cent from March through June, topping out at a massive 12.5 per cent in May – nearly five percentage points higher than the official inflation rate reported by Statistics Canada that month.
The problem, they say, is that this standard measure of the inflation rate is a rear-mirror view. It looks at how much prices have increased over the entire past 12 months, rather than focusing on the current, or at least recent, speed of price increases.
“This year-over-year rate of change in CPI provides very limited information on the inflation we are currently experiencing,” they said in their report.
A better gauge, they argue, would be something they call the “prospective rate” of inflation (as opposed to the “retrospective” view that our standard year-over-year inflation rate provides). This entails focusing on more recent CPI increases – over the past month or the past three months, say – and compounding and annualizing those numbers. This, they say, provides a much better indication of the erosion of consumers’ purchasing power should the current pace of inflation continue.
The researchers liken this to the speedometer on a car. The traditional year-over-year inflation rate is similar to calculating the average speed that our car has travelled over, say, the past hour. The prospective gauge, like the speedometer, tells us how fast we are moving right now – giving us a clear indication of how far we will travel in the next hour at our current speed.
Specifically, Mr. Petkantchin and Ms. Elgrably-Lévy look at the change in CPI over the past three months – which provides a snapshot of the relatively recent trend – and compound it annually to come up with their inflation rate. The results are illuminating.
They found that this gauge signalled rising inflation pressures much earlier than the year-over-year inflation rate. The prospective rate has been consistently above the upper limit of the Bank of Canada’s 1-to-3-per-cent inflation target band since the fall of 2020, while year-over-year inflation only topped 3 per cent in the spring of 2021. It has been consistently above the official inflation rate throughout the recovery from the COVID-19 recession, peaked much higher, and turned downward earlier than the official rate.
“It’s a little bit like the canary in the mine,” Mr. Petkantchin said in an interview last week.
The measure is certainly more sensitive to short-term volatility in prices, and, thus, would need to be used with caution. The latest inflation trend is not always a good indication of the underlying pressures that will sustain the pace of broadly based price changes over time. Still, by looking at the three-month trend and annualizing it, you do at least get some smoothing of very short-term price swings and anomalies. And the measure does appear to do a superior job of flagging shifts and accelerations in the trend.
The MEI researchers are certainly not the first experts to question the accuracy and usefulness of Statscan’s official inflation readings. Indeed, CPI inflation has been a favourite target of critics for many years. They have questioned the makeup of the hypothetical basket of consumer goods that Statscan measures each month, and the weightings the agency places on individual items within that basket. They have long taken issue with Statscan’s interpretation of housing costs and the effect of interest charges on the inflation calculation. Some question the methodology used to gather the data from retailers.
By comparison, the issue Mr. Petkantchin and Ms. Elgrably-Lévy want to address is very straightforward. They merely want to take the existing data, as is, and slice them in a more timely and useful way.
The researchers said that until 2007, Statscan actually published a nearly identical three-month annualized inflation calculation every month, called “Consumer Price Index (CPI), three-month seasonally adjusted cumulative movement compounded to an annual rate.”
It’s not clear why the agency discontinued this statistical series. A statement from Statscan spokesperson Kathleen Marriner last week suggests the agency has concerns about the usefulness of the gauge as a forward-looking indicator.
“While annualizing monthly or quarterly price change can be a useful tool for looking forward, this cannot account for sudden events that may impact prices (e.g. the impact of the Russian invasion of Ukraine on energy prices, weather events, etc.), and so the annualized rate does not necessarily reflect the direction of the CPI going forward,” Ms. Marriner said in an e-mail.
Despite those concerns, now might be a very good time for Statscan to restart this measure. We’re in the midst of the most-critical period for inflation in more than a generation. To say it would be helpful to have a richer analysis of CPI – and more timely indicators of turning points in the inflation trend – would be an understatement.
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