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Insights & advice

What is inflation and how does it impact Canadians?

October 2022 – 15 min read

Key takeaways

  • Inflation is the increase in the price of goods and services in an economy

  • There are 3 situations that cause inflation

  • Inflation is measured with the consumer price index

  • A 2% inflation rate is good for the economy

  • High inflation hurts consumers because it decreases their standard of living

  • There are strategies you can use to combat the effects of inflation

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What is inflation?

Inflation is the steady rise in the price of goods and services in an economy over time.

Three causes of inflation

Prices generally rise when the demand for a good or service is higher than the supply of that good or service. There are 3 ways this can happen. 

Cost-push inflation

This happens when the demand for something stays the same while the supply falls because of higher production costs such as raw materials or wages. Rising gas prices are an example of this type of inflation. 

Demand-pull inflation

This occurs when the demand for a product or service rises significantly and the supply in the economy can’t meet that demand. The global economic recovery from the pandemic is an example of this type of inflation. Consumer demand for good and services that weren’t available for many months is increasing, while supplies of those good and services can’t keep up. The result is high prices. 

Built-in inflation

This happens because consumers get used to the idea that current inflation rates will continue, and therefore expect wage increases to maintain their standard of livingOpens in a new window. This wage increase results in a higher cost for good and services, and the cycle repeats.

How inflation is measured

Economies measure the rate of inflation using the change in consumer price index (CPI). Statistics Canada calculates the CPI by tracking the month-to-month change in prices for a sample basket of 700 goods and services Canadians typically purchase. 

If in 1 year, that basket cost $100, but the next year the same basket cost $102, then the average rate of inflation would be 2%.

Is inflation good or bad?

According to the Bank of CanadaOpens a new website in a new window - Opens in a new window , a low, stable and predictable inflation rate is good for the Canadian economy. If businesses and consumers believe they know what the inflation rate will be going forward, they can plan for the future. This leads to an economy that functions better and grows. 

The Bank of Canada tries to keep inflation close to 2% because it believes at that rate the demand for goods and services is almost equal to supply. 

If the inflation rate is below 2%, the Bank of Canada lowers interest rates to encourage businesses and companies to borrow, spend and invest. 

If the inflation rate is higher than 3%, the Bank of Canada raises interest rates to slow down borrowing and spending to bring the economy closer to demand equalling supply. 

According to a July 2022 surveyOpens a new website in a new window - Opens in a new window , 71% of Canadians follow the Bank of Canada’s interest rate adjustments closely or very closely, while 24% aren’t watching as closely and 5% aren’t following at all.

What high inflation does

When prices rise too quickly, consumers can’t afford to buy as much which lowers their standard of living. As well, people, businesses and investors don’t know what their costs will be. This instability and unpredictability hurts the economy. 

High inflation is most difficult for pensioners and low wage earners whose incomes may not be able to keep pace with inflation, lowering the value of their incomes and savings.

Hedging against inflation

Hedging is a way to manage financial risk. An inflation hedge helps protect you from falling purchasing power. 

Investing in equities are a great way to combat inflation because rising stock prices include the impact of inflation. In addition, purchasing equities using dollar-cost averaging also helps to hedge against inflation because you’re purchasing stocks at a range of prices from lower to higher.

Managing high inflation as a consumer

There are several ways you can weather periods of high inflation as a consumer.

  • Delay large purchases (such as vehicles or home renovations) until demand and prices fall.

  • Watch your grocery spending by buying in bulk, price matching, using coupons, using grocery store points plans, or meal planning

  • Pay off debt especially high-interest credit card debt if you can

  • Drive less by carpooling, grouping errands, taking public transit, cycling or walking

  • Track all your spending to keep a closer eye on everything you purchase and determine where you might be able to spend less or not spend at all

The information provided is based on current laws, regulations and other rules applicable to Canadian residents. It is accurate to the best of our knowledge as of the date of publication. Rules and their interpretation may change, affecting the accuracy of the information. The information provided is general in nature, and should not be relied upon as a substitute for advice in any specific situation. For specific situations, advice should be obtained from the appropriate legal, accounting, tax or other professional advisors.