With interest rates rising, inflation is top of mind for Canadians. But what exactly does inflation mean? According to Google search trends, that term is something Canadians have lots of questions about.  

In this episode, we answer some of the top trending Google searches on the subject. Think of it as a sort of “Inflation 101.” 

We get to the bottom of things like, “What is inflation?”, “What is the inflation rate?”, and “How does inflation affect personal finance planning?”  

Olena Ivus, Associate Professor of Business Economics at the Smith School of Business at Queen’s University, is our guest and will lead our search party to some answers. 

Click here for the transcript.

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Transcript:

Stephen Meurice: If you’ve a regular listener to the show — there’s one word you’ve probably heard repeated more than any other so far this year.  

[Montage of Stephen and guests saying “inflation”]  

Yep, that’s just a sample of all the times we’ve mentioned, ‘inflation’ in the past few months.   

But it’s not just us talking about it. According to Google search trends, inflation is something people have lots of questions about.  

So today, we’re taking a step back. We’re going help answer some of Canadians’ top trending questions around inflation.  

[Montage of voices and sound of typing]  

Voice 1: What is inflation? 

Voice 2: What is the inflation rate? 

Voice 3: How does inflation affect personal finance planning?  

[Voices fade under]  

SM: If inflation is top of mind for Canadians—and likely will continue to be for the foreseeable future—we might as well have a good handle on the basics.   

So we‘ve enlisted Olena Ivus. She’s an Associate Professor of Business Economics at the Smith School of Business at Queen’s University. She’s our guest this episode. And will lead our search party to find some answers.  

And hey, I know our listeners tend to be pretty economically savvy. So, to those who already know these answers — here’s your assignment: send this episode to someone who might not. And who knows, maybe you’ll even learn something, as well.  

I’m Stephen Meurice and this is Perspectives. 

Olena, welcome to the show. Today you are our human search engine.  

OI: Thank you, Stephen. Thank you for having me and it's a pleasure to be here. 

SM: Okay. Our first trending question gets right to the point, ‘What is inflation?’ 

OI: Well, you can think of inflation as a general increase in price. So, inflation is when the overall price level rises. Some prices may be rising more than others. Some prices might be even falling. But overall, at the general aggregate level the prices are rising.  

SM: Okay, so I think most people sort of intuitively understand, you know you see old Coca-Cola ads from the nineteen hundreds and a bottle of coke is 5 cents or something and they see it's not 5 cents anymore. So, they understand that prices increase. But why does inflation happen? It seems like a law of the universe. Like the sun sets in the west, flowers bloom in the spring and the prices stuff just goes up. It seems like a guarantee. 

OI: It's not a guarantee. The price, if you look at the long time series of data, then yes we see positive trends in price levels. So, price levels have been rising. But there are a lot of fluctuations around that trend. Sometimes they may even fall, in which case we will be referring to negative inflation.  

SM: So why does it happen? Why do prices increase? 

OI: Well, that can be a lot of different causes. But typically — at least in a short run — if the economy is booming, there is an increase in aggregate demand for goods and services. That tends to push prices up. Prices could go up because there is excessive demand. Prices can go up because the costs of production rises.  

SM: So, there's a bunch of different factors that can lead to inflation.  

OI: Yes, you can't really point to a single one and say, ‘this is the main reason.’  

SM: Okay so our next trending question around inflation is, ‘What is the inflation rate?’  

OI: In simple words, inflation rate is a rate of increase in the average price level or aggregate price level. Typically, we measure inflation in terms of percentage increase per year and that price level can be measured with a variety of price indexes. But the most common price index and that's the one that the Bank of Canada heavily relies on is the so-called Consumer Price Index or CPI simply. So, a lower rate of change in the Consumer Price Index means prices are rising, but slower. And if the rate is negative, then prices are actually falling. But you can think of a more sort of intuitive indicators such as restaurant menus. If prices are particularly volatile, then it is quite costly for restaurants to update their menus frequently. And in this case, restaurants tend not to fix their prices on menus — by for example laminating their menus — rather they would give you paper menus so that the cost of updating the menu is not as high.  

SM: Hmm. So, if you see chalkboard menus or paper menus, that's an indicator that restaurants can't keep track of how quickly prices are going up.  

OI: Exactly. That's an indicator that prices are very volatile.  

SM: Well that leads us to our next search question, ‘What is the perfect inflation rate?’ Is there such a thing?  

OI: There is a sort of a magic number that the Bank of Canada is targeting and that is 2% per year. Which means prices do not grow very fast. They grow at a slow enough rate that they can be considered stable. And they roughly double every thirty-six years. If the rate of inflation exceeds 3%, that must be addressed. 

SM: And why does there need to be any inflation at all? As a customer who buys groceries and other things, don't I want prices to stay the same or even to come down? For things to get cheaper? Why would that not be good?  

OI: Because if prices have fallen, then you don't want to spend that much money today. If those same goods will be cheaper — let's say, a month from now — then you would rather postpone your spending. So, the demand for products today falls if there is an expectation that prices will fall in the future. So, consumers delay their spending. Firms delay their investment spending and that slows the economy down. And if it slows down by much, then we will move into recession. 

SM: So, a certain amount of inflation is good, but it needs to be stable. 

OI: Exactly. So, a small increase in prices is actually good for the economy because that boosts the economy. But at the same time, you want it to be stable and you want it to be expected. 

SM: Okay, so expectations are part of it as well. What people think is going to happen can drive their behaviour.  

OI: Yes, exactly, expectations is a very important driver here. And in general the expectation of inflation could be enough to spark an inflationary period. If consumers for example are afraid that prices will go up, then they may end up spending more today in order to guard themselves against future price increases and that may lead to a faster increase in prices.  

SM: Okay, this is going to lead us to our next question, but just to recap: the Bank of Canada believes the perfect inflation rate is about 2%. Once it starts going over that, individuals and businesses start to get a little bit freaked out about what's going on in the economy. Is that right? 

OI: That's exactly right. And it is important to make sure that people do not expect high inflation, otherwise you're right, they freak out. They start to demand more goods today. Employees start demanding higher wages and that in itself can lead to a scenario where inflation is out of control. And it is extremely difficult to bring it down once it gets there.  

SM: Okay, that's a perfect lead into our next Google trending question about inflation, which is, ‘What can the government try and do to reduce the rate?’ 

OI: So, it really depends here what is driving the inflation. But if the inflation is due to excessive demand, then one key policy change for the Bank of Canada is to increase the interest rate.  

SM: Okay. Interest rates are something we talk a lot about on the show. The Bank of Canada has been raising rates this year to try to curb inflation. How does increasing interest rates slow inflation? 

OI: If interest rates are higher, then it is more costly for people to borrow money and that reduces personal consumption. For firms that is more costly to borrow money and that reduces investment. That slows down the aggregate demand in the economy and tends to push prices down.  

SM: Right, so basically it means slowing down the economy.  

OI: Yes.  

SM: Right. So, when you have a higher interest rate, that means people and firms spend less money, basically. They buy less stuff, invest less in their businesses. That means there's less demand and so the prices of things come down. And that's how inflation comes down.  

OI: Exactly, consumption spending and investment spending falls and with that aggregate demand falls. And a decline in aggregate demand tends to push prices down. 

SM: Okay and speaking of consumers, our final question is something I'm sure a lot of our listeners are curious about, ‘How does inflation affect personal finance planning?’  

OI: So, at the very basic level, the in impact of inflation is negative because you will not be able to take your paycheque that far, you won't be able to buy as many goods with your existing paycheque.  

SM: Unless your paycheck rises at the same rate as inflation, right?  

OI: Exactly. In that case, in real terms, your money is not losing any value with inflation. Because it rises at the exact same percentage as the actual inflation rate.  

SM: Right. Right.  

OI: We tend to think that inflation will make everyone poor. That's not quite so. Because if prices are rising, wages and incomes might be rising as well. And what we care about is what is rising faster? What matters also is what income bracket you are. Low-income earners tend to be hit harder by inflation because most of low-income earner’s wealth is in cash and inflation simply destroys the value of cash. If you are a mortgage holder and inflation unexpected rises, then that will actually benefit you. Because the real value of your debt is reduced as a result. 

SM: Okay, so I'm going to try to sum up everything we've learned here in our inflation 101 lesson. Inflation is increasing overall cost of the products that we buy. These are measured using the Consumer Price Index. When inflation starts to get too high, the Bank of Canada responds by increasing interest rates, which can slow demand. People buy less stuff. Companies buy less stuff, invest less money so it slows down the economy, decreasing the demand for those goods and helping bring down the prices of those goods. 

OI: That’s exactly right. 

SM: What grade do I get? B+? 

OI: A+ 

SM: A+. Excellent. 

[laughs] 

SM: Olena, I want to thank you so much for your help today. I think my brain has been slightly inflated thanks to our chat.  

OI: Thank you very much, Stephen. And I wish everyone a lot of ups in their life, but not so much in terms of prices. 

SM: [laughs] I've been speaking with Olena Ivus, Associate Professor of Business Economics at the Smith School of Business at Queen's University.