Inflation and the central bank... again

Let's continue this exercise to prove a point, and because I find it interesting.

How Sticky is inflation

Here is the price increases/decreases for certain goods. Let's see how much well the the Bank of Canada has achieved price stability.

UP
Cereal products (excluding infant food): +5.1 per cent
-Cereal is produces in Canada, so the BOC failed to achieve price stability here.

Preserved fruit and fruit preparations: +5.6 per cent
-Most from Western countries, failed here as well.

Canned vegetables and other vegetable preparations: +12.6 per cent
-Same here

Sugar and confectionery: +8.6 per cent
-Wow, big increase here, and quite difficult to import confectionery goods, so failed here.

Telephone services: +5 per cent
-All Canadian companies here.

Pet food: +8.5 per cent
-I don't think we import much pet food from China anymore. failed.

Car insurance premiums: + 7.9 per cent
-Big failure here.

Rail, highway bus and other intercity transportation: + 9.3 per cent
-This is a made in Canada problem. Failed

Health care services: + 4.5 per cent
-Although I believe this to be the BoC's responsibility, this could be because government run systems will always get more expensive and inefficient. I will give them the benefit of the doubt here.

Tuition fees: + 4.1 per cent
-Here I will not give them the benefit of the doubt. Tuitions are increasing in large part because students are able to take on more debt.

I hope you notice the pattern, all services that cannot be outsourced are up quite significantly.

DOWN
Ham and bacon: -2.1 per cent
-Not too sure why this is. Let's give them the benefit of the doubt again, they achieved price stability here.

Pasta: -5 per cent
-Likely due to the appreciation of the dollar vs the Euro due to problems in the Euro zone. Not much influence here.

Potatoes: -21.7 per cent
-This is a pullback from the huge increase a year or so ago.

Mortgage interest cost: -5.8 per cent
-This is all BOC. Well done. Of course, this is a ridiculous inclusion. It's like including the interest rate on your car, and not the actual price of the car. The price of the car can double, but as long as the interest rate doesn't change, no impact on inflation. Just ridiculous.

Natural gas: -22.8 per cent
-BOC has little to no impact on Commodities.

Furniture: -4.25
-Thank our friends in CHINA

Women's clothing: -8.7 per cent
-China again.

Air transportation: -9.5 per cent
-I haven't notices a decrease, but let's give them the benefit of the doubt again.

Home entertainment equipment, parts and services: -8.0 per cent
-Thank you China.

Car rentals: -4.5 per cent
-Thank you US Government, keep on pumping out more cars to keep your union buddies working.

In conclusion, the Bank of Canada has a failed to achieve price stability. All products that have increased in price with the (possible but unlikely) exception of Health Care are due to the BoC's low interest rates, They only achieved price stability (giving them the benefit of the doubt) for Pork, mortgage interest, and Air Transportation.

I hope everyone can see that the BoC has had little impact on the low CPI numbers we have had in recent years. What should be clear to everyone is that if the money supply increases by 5%, our GDP doesn't change, and our CPI is 2%, that extra money goes somewhere. By ignoring this extra money, you risk creating huge bubbles and malinvestment.

Transparency and the Bank of Canada

This article was pretty interesting. At Bank of Canada, a debate on revealing less - The Globe and Mail

There are two comments I'd like to make, one about transparency and one about price-level targeting.


From the article.
There is an emerging opinion that central banks contributed to the financial crisis by making their intentions for interest rates too predictable. The best example is the U.S. Federal Reserve, which, under former chairman Alan Greenspan, raised its benchmark interest rate in 17 quarter-point increments starting in June, 2004, and ending with the Fed funds rate at 5.25 per cent in June, 2006.

The worry - it must be said, in retrospect - is that too much transparency causes investors to become complacent.

Thinking they have the central bank's interest-rate path figured out, investors put less effort into assessing economic fundamentals. This creates a kind of groupthink that removes an important check on exuberant behaviour: skepticism.

In 1996, Greenspan spoke about "irrational exuberance". "Irrational exuberance" would imply tightening ahead, and so it appears that Greenspan was very transparent of his intentions. Yet the market ignored this, and the Nasdaq went on to inflate and burst.

Could it be that what Fed does is much more important than what the chairman would say? Apparently not, according to emerging opinion.

The second point is about price-level targeting. As I have showed in previous post, the Bank of Canada has little effect on inflation, and what areas it does have an effect on, it is doing a poor job. So what price-level targeting do to the Canadian economy? It would only exacerbate any problems.

I work under a simple premise, that if the interest rate set by the Bank of Canada is lower than the interest rate that would be set by the market, then you have malinvestment, and malinvestment is bad and will eventually need to be cleansed from the economy. The most recent examples were the housing bubble and the Nasdaq bubble in the US. The 1% interest rate in the US, which would be below any reasonable estimate of a market interest rate, caused investors to act under false pretenses. Low interest rates should mean that there is a large amount of capital available (ie. people have so much money that they are willing to lend it out at 1%), but of course this was not the case, there was not an abundance of capital. Central banks misled investors by lowering interest rates to such levels.

So why will price-level targeting exacerbate problems in Canada? Well Canada currently has a CPI of 1.9%, lower than their target of 2%. Well if China's over-capacity allows them to sell us goods for lower prices, then Canada's CPI will be below 2% for the foreseeable future. This would mean that the Bank of Canada could keep rates at near zero, and will snowball the malinvestments. With a price target of 2%, you could simply ignore the year and look forward, but with price-level targeting, you will need to keep the interest rate at an artificially low level which of course would increase the amount of malinvestment. (And the more malinvestment, the worse the recession/depression will be)

Well, if the Chinese decide to pass on their inflation to Canada, our CPI could easily go up to 3%, and stay there. That means that for the foreseeable future, the Bank would continually increase its interest rates to fight a fire that it has very little control over. Again, price-level targeting, would mean the BOC will need to continually increase the interest rate to get the average to 2%. And this of course will cause the currency to appreciate, and destroy the economy.

Now if the BOC was really serious about price-level targeting (It would be really nice if the target was 0!!), it should first look seriously at how it calculates CPI and base the price-level targeting on only this items that it actually has control over (perhaps just services?).