Canada renews inflation target, with a new wrinkle or three

The Bank of Canada has been using an inflation target of 2 percent as its main monetary policy guidepost since 1991. The Bank and the Government review the target every five years and tweak it as appropriate.  Today the Bank announced that the target is to be renewed for a further five years, but with some quite significant changes in the way the inflation level is assessed.

The inflation target notionally focuses on headline CPI, but because of the volatility in that series, the Bank has mostly focused on a "core" measure known as CPIX, which omits items such as gasoline, fruits and vegetables and mortgage interest. However, the Bank has found that CPIX is no longer giving a reliable reading of underlying price trends.  In part this is happening because of administered price changes that have nothing to do with underlying price or cost pressures.  The soaring cost of electricity in Ontario as a result of the Provincial government's aggressive "green" strategy is an obvious example; the cumulative impact of the planned carbon levy in the next few years may well be another.

In the opposite direction, prices for some products behave counter-cyclically, falling when the economy is weakening.  The Bank cites new car prices as an example here. Such price movements do not accurately reflect capacity constraints in the economy, which are one of the key factors the Bank is looking to focus on as it attempts to set monetary policy.

Going forward, the Bank will now look at three new measures of underlying inflation, known as CPI-trim, CPI-median and CPI-common.  These measures, fully described in the technical paper linked above, all attempt to give a more accurate read on inflationary pressures than either CPI or CPIX is capable of doing.

It's tempting at first blush to think that the Bank of Canada is going down the road once taken by Alan Greenspan at the Fed.  The "maestro" was forever searching for new inflation measures to support his gut feel that price pressures were low.  After a brief dalliance with the employment cost index (ECI), he eventually settled on the entirely unmemorable core personal consumption expenditure deflator.  

However, that's not what the Bank of Canada is up to here.  With inflationary pressures as low as they are in Canada right now, there's no need for the Bank to put up any kind of smokescreen.  The purpose of adopting the new measures is exactly as stated: to give the Bank a better read of what's going on.  That said, the proliferation of new measures is unlikely to improve public understanding of the inflation targeting regime.  Given that a large number of Canadians sincerely believe that the inflation rate is way higher than what is reported by StatsCan each month, there are bound to be a few conspiracy theories online and in the letters pages in the next few days.