Inflation this fall is being driven by only 6 among 200 prices.
The inflation drivers would have happened with or without government pandemic supports.
Most provincial/territorial seniors, child and sales tax credits aren’t indexed to inflation.
Most provincial/territorial minimum wages are indexed to inflation.
Most social assistance programs aren’t indexed to inflation.
Quebec has all five major support types for low-income citizens indexed.
The federal government has four (out of five) categories indexed.
Alberta, NWT and Nunavut have none of the major support categories indexed.
High headline inflation figures over the course of the fall have been gaining a lot of attention lately. There is concern that these price increases are a result of the economy overheating and that the appropriate policy response is for the Bank of Canada to drive up interest rates in reaction. In particular, the concern is that government responses to the pandemic, which went to support businesses and the jobless, are driving that inflation.
However, a detailed analysis shows that the main drivers of inflation are incredibly concentrated among only six price categories out of the roughly 200. The key areas causing high inflation in Canada in the past six months are gasoline along with natural gas and fuel oil for home heating (combined in the graph below), the price of houses, the cost of purchasing vehicles and the cost of meat.
Let me be clear: just because the headline inflation numbers are being impacted by a very small number of commodities doesn’t mean inflation isn’t affecting Canadians. After all, people certainly buy gas, heat their homes, and purchase houses, cars and meat. The point is that this round of inflation isn’t broad based and would have happened with or without government pandemic supports.
There are also measures that federal, provincial and territorial governments can take to ease the burden of rising costs for lower-income Canadians, namely indexing their benefits and minimum wages to inflation. As I explain in the latter half of this article, almost all governments haven’t indexed all of their seniors, child, sales tax and social assistance benefits, as well as minimum wage.
Breaking down fall inflation
To illustrate just how much each of these six areas are adding to the headline Consumer Price Index (CPI), see the graph below. In October 2021 (the most recent month of data), the headline inflation figure was 4.65% compared to a year earlier. Of that 4.65%, 1.29% was due to gasoline and home heating, 0.56% was due to home price increases, 0.36% was due to new vehicles and 0.2% was due to meat price increases. The CPI without these categories was a much more normal 2.25% (4.65 – 1.29 – 0.56 – 0.36 -0.2=2.25). Had those areas seen price increases similar to the rest of the CPI items around 2% (instead of 42% in the case of gasoline) they would have added nothing to the headline figure.
The biggest impact on CPI, by far, is the effect of high oil prices on gasoline costs at the pump, but also on home heating fuels like oil and natural gas. This grouping has been adding 1% to 1.9% points to the headline inflation figure since March. In other words, in October alone, the CPI figure would have been 1.29% points lower (or 3.37% instead of 4.65%), had these three categories seen more normal price increases. Of course, these price increases have nothing to do with the wage subsidy or the Canada Emergency Response Benefit (CERB), and everything to do with international oil prices, which have skyrocketed over this period. Incidentally, the rapid recovery of oil prices has led to rapid recoveries in the provincial finances of Alberta in recent months.
Because of record low interest rates, more people buying houses as investments. This, along with a rush to buy larger houses due to the shift to working from home, has meant house prices have skyrocketed. This has added 0.25% to 0.6% to the headline CPI figure since April. If house prices were increasing at more normal rates in October, the CPI figure would have been 0.56% points lower at 4.1% instead of 4.65%. Investors using low interest rates to bid up home prices has nothing to do with government pandemic supports.
The microchip shortage has received plenty of attention although, in the inflation context, the biggest impact is in the higher cost of new vehicles. Cars and trucks aren’t being made as quickly due to the lack of chips, resulting in supply backlogs and higher prices. This shortage has been adding 0.3% to 0.5% to the headline CPI since March. In October alone, the headline CPI figure would have been 4.29% (or 0.36% points lower) had car prices not gone up so quickly. The microchip shortage has nothing to do with federal or provincial support for businesses or individuals.
Twenty per cent of grocery costs are for meat, and meat prices are up 10% since last year. This one category added 0.2% points to the overall CPI figure. If you remove meat from the grocery basket, but leave the other items (fruits, veggies, dairy, fish, bakery and non-alcoholic beverages), grocery costs are up only 2.5% since last year, much closer to normal. This isn’t to say that grocery prices aren’t going up—it's just to say that the increase in meat costs have been a key driver.
It’s worth noting that the beef processing industry in Canada is incredibly concentrated. Three plants—Cargill’s High River facility, the JBS plant in Brooks, Alberta and the Cargill plant in Guelph, Ontario— together process over 95% of the beef in Canada. For its part, Cargill recently reported its largest profit in 156 years: USD$4.9 billion in 2021 in part because of the surging beef prices.
Preview of the future: Lumber
As a preview of what fluctuating commodity prices, like oil and gas, can do to influence the CPI, we need only look at lumber prices. Sometimes it seems like the rise in commodity prices will continue upwards and stay high forever. But supply chain issues can resolve themselves and commodity prices not only moderate, but fall, as they did for lumber. In the spring, the cost of lumber went through the roof and was expected to be high for years to come, further driving up the price of houses (among other things).
But then it crashed right back down again by the fall. There aren’t many items in the CPI that directly reflect the cost of lumber. The cost of a two-by-four, for instance, isn’t part of the CPI, but wooden furniture is (although its weighting in the CPI is only 0.5% of the total basket). The graph below shows wooden furniture price inflation since 2019. The peak is quite clear, but so is the subsequent moderation back down to more normal levels with further declines in price likely coming.
Protection from inflation
One of the roles that governments can play in combating the burden of inflation is making sure that the poorest aren’t pushed further into poverty as a result. Government supports should be indexed to inflation, and should increase at least at that rate. This will ensure lower income households can continue to buy gas, cars and meat (lower income households almost always rent and don’t buy houses).
Although common, indexation is by no means universal for Canadian programs, leaving many low-income households vulnerable.
The largest amounts that Canadians get in income transfers come from the federal government and they are generally indexed. For families with children, the largest support is the Canada Child Benefit, which is indexed. For seniors, the largest support is the Old Age Security and Guaranteed Income Supplement which are both indexed. In terms of social insurance programs, the Canada Pension Plan and Employment Insurance are the largest and these are also indexed (EI payments are related to income and the maximum insurable earnings amount rises with inflation).
Many of the provinces have additional top ups. The major income transfer programs examined here are seniors’ benefits, child benefits and sales tax rebates, all of which are generally geared to income. In some provinces, there are additional supports for low-income households, although the ones in the table below are the major rebates administered through the tax system.
If we look at the provincial versions of these programs, most child benefits, seniors’ benefits and sales tax rebates are not indexed and so those supports are not protected from increases in inflation, if those supports exist at all at the provincial level.
The income assistance of last resort, social assistance, is provided by the provinces, although the federal government provides social assistance on reserves via the On-reserve Income Assistance program. In most cases, social assistance rates are not indexed to inflation, meaning the most vulnerable could see a substantial hit with the high inflation this fall.
Minimum wages are another important way to maintain incomes for the working poor. Each province or territory has a minimum wage, as does the federal government. Most minimum wages are indexed to inflation, though not all.
Quebec has indexed all five of the major categories of support, providing the poorest in that province with the most protection against rising inflation. The federal government has indexed four of the major categories. For social assistance on reserves, the federal government matches the provincial rates; since most of the provinces haven’t indexed them, neither has the federal government, although a different policy choice could be made.. Ontario and the Yukon rank third with three of the five major categories indexed. Alberta, Northwest Territories and Nunavut sit at the bottom with no inflation protection in any of these five categories for their lowest income residents.
While indexing key benefits to inflation will allow poorer Canadians some protection from this rise in inflation along with future ones, it doesn’t guarantee these programs provide adequate support in the first place. In many cases, in fact, they do not. The table above only points out whether recipients will fall even further behind as a result of high inflation this fall.
Inflation is certainly real and is costing Canadians more, but prices are quickly rising in a few very specific areas and those increases are unlikely to be long term. Outside those areas, inflation is roughly what would be expected in a normal economy.
The prices driving our inflation this fall—gasoline, home heating, cars, houses and meat—are not related to government pandemic supports, and are likely to subside. Moreover, the standard response to inflation—boosting interest rates—isn’t going to reduce gas prices, deliver microchips to car factories or loosen tight control of the beef processing. Higher rates would likely have an impact on house prices but at the cost of slower wage growth.
Despite the likely transitory nature of this inflation, many of the poorest Canadians won’t be protected. While most minimum wages are indexed, provincial and territorial supports for families with children, seniors and sales tax rebates generally aren’t, and neither are most social assistance rates.
Providing indexation for low-income benefits is straightforward and easily accomplished. In many cases, the rapid economic relaunch has replenished government coffers, offering them the means with which to do so.