Last month, prices rose in all eight major components on a year-over-year basis, primarily driven by the surge in gasoline prices, which spiked 47.1% from year-ago levels. Extreme drought, especially in China, led to a dearth of hydroelectric power and shortages in other energy sources such as coal and natural gas. The shift to oil for power generation boosts the cost of oil and gasoline. It also caused a domino effect in shortages of other essential materials that require intensive energy use in their production, such as fertilizer and aluminum. These feed into shortages of food and metal components that raise the price of many consumer goods. Combine this with disruptions at the ports, in trucking and on the rail lines. It is no wonder that increasing costs and excess demand are driving up consumer prices worldwide.
The question is, would central bank tightening reduce this kind of inflation. I doubt it. Instead, we are likely to see these pressures ease over time (see chart below). The problem is we have repeatedly underestimated the time it would take to work this all out, leading some to call for a quicker response by the Bank of Canada and the Fed, among other central banks, for fear that the inflation will become embedded.
Embedded inflation, caused by rising wages and inflation expectations, led to wage-price spiralling in the 1970s and early 1980s. In Canada, inflation remained high well into the early 1990s because of substantial federal and provincial budgetary spending. I do not believe we are anywhere near that reality today. To be sure, fiscal policy in response to the pandemic has generated extraordinary budgetary red ink, but price pressures today are not the result of budgetary actions. |
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