Inflation - the obsession

The consumer price index (CPI) is a basket of +/- 700 products/goods divided into eight main components whose variation is measured between two given dates. Basically, that's it. To reassure us, they modify this list by adding and removing products over time based on the consumption of the population so that the index basket is representative of the consumption habits of citizens. For example, the budget allocated to the purchase of DVDs, which was significant in the 1990s/2000s, is no longer so now. Then the elements of the basket are weighted according to the importance of this element in the average budget of the population. Basically that's it!

This is where the questions arise. One of the main mechanisms, and it seems the only one used by the government, to curb inflation is to increase the central bank's policy rate rate, which influences the borrowing rate of the banks and, incidentally, interest rates at the consumption. The idea behind it is that by increasing interest rates people will consume less and therefore inflation will subside. Basically that's the idea. On the other hand, after 8 consecutive increases in the key rate, inflation is not falling. No impact.

Let's talk a bit about the items in this basket. The proportion of the CPI basket that is attributed to housing expenditure is almost 27%. If I understand correctly, we are increasing the key rate to curb inflation, the main index of which is more than a quarter of the index and is housing, which makes up, among other things, (rental housing, owner-occupied housing, Energy/Electricity). Raising the policy rate has no short-term effect on rental rents. A lease is signed, the management limits the increases during the renewal to the CPI, therefore possibly a medium-term effect but upwards and not downwards. Has your housing decreased lately?

Follow my reasoning. The policy rate is raised to curb inflation. By the same token, rents do not decrease in the short term and increase in the medium term and therefore increase the CPI. Let’s look at the first item of the main component (Housing) which represents 16.1% of the entire CPI, i.e. the cost of owner housing. Home/condo owners. The policy rate is raised on the pretext of curbing inflation. For those who have a fixed rate on their mortgage, zero impact in the short term. The rate is fixed. On renewal, however, there is an immediate impact since the rate will be higher, thus increasing the cost related to the mortgage. For those who have a variable rate mortgage, the impact is immediate, i.e. the increase in housing expenses. This same expense that influences the CPI by 16.1%! Are you beginning to understand? In short, we increase the key rate to curb inflation, thereby the expenses related to 26.92% of the index increase and we wonder why the inflation rate is not falling. Am I crazy or what?

The third item of expenditure is electricity, which represents 2.4% of the CPI baskets. Well suddenly, that too has increased! But yes it costs more to produce electricity, inflation, the salaries of Hydro-Québec officials, but yes it makes sense! So we increase the key rate in order to curb inflation, that sworn enemy. Yet I have just demonstrated here that in fact more than a quarter of the index is pushed up, further affecting the CPI upwards and thus inflation! Mind-blowing no!

The second largest item in the CPI, nearly 20% of the index, is the cost of transportation, which is obviously greatly linked to the price of gasoline. In Quebec, the price of gasoline is greatly affected by the enormous weight of the various taxes on gasoline and by the fact that we are not a producer. In short, the increase in the key rate has no impact on this component, we agree. What could help to reduce this expense would be for the government to reduce taxes on gasoline, say by 5%, which would have an immediate impact on the cost of transport and therefore on the CPI of possibly 1 half of 1% . But no, we are increasing the key rate.

The third main item in the CPI is the cost of food, which represents more or less 16% of the total index. This item is also influenced by the cost of transport, which implies that a reduction in transport costs has a double impact on the CPI. As for this component, do you think that increasing the key rate lowers the cost of food? Zero impact, Zero! On the contrary, the increase in housing costs and transport costs necessarily influences supply costs and also, obviously, wage demands. But yes it goes without saying.

I summarize, on the 3 main components of the consumer price index which represent more than 60% of the index, the increase in the key rate has zero impact or, in the case of housing, an impact at index increase. And I don't surprise you if I tell you that it's the same effect for the other main components (Household current expenditure, Clothing/Footwear, health care/beauty, leisure, training, reading, and alcoholic beverages, tobacco) i.e. zero impact .

So what exactly are we doing? We are obsessed with inflation, which is totally aligned with the capitalist system, which assumes the increase in profits from year to year and therefore in the price of goods. Inflation in our system is willed and desired. Obviously we do not want the price of consumer goods to increase by 15-20% per year, we agree. But an increase is still desirable for a “healthy” economy.

In conclusion, the main drag mechanism on the economy is the increase in the key rate. Certainly, but to curb inflation I have demonstrated with my limited knowledge of economics that this has no downward impact but even on the contrary pushes inflation upwards. Notwithstanding my basic demonstration, the 8 raises in a row also seem to prove me right. The inflation rate in 2021 was 3.5% it is now 6.3%.

If the government really wants to curb inflation and bring it back to “order” by 2-4% then all it has to do is lower: gas taxes, property taxes, taxes, electricity costs and policy rate reasonably 3-4%, not necessary to be at 1%. Just a modest drop in these elements influences the CPI immediately and we are no longer talking about inflation but about a healthy economy. Instead of obsessing over the inflation rate, the government should make sure to allow the middle class to exist and businesses to survive.