Peter Hall: Why the Bank of Canada should ignore the July inflation spike

Let’s remember, this is inflation that is caused by central bank actions — one of those strange situations where the antidote is the venom itself. But if so, shouldn’t the measure of success be the price path of everything but mortgage interest costs? Seems reasonable.

Dissenters would counter that mortgage interest costs are too small to matter. True, the 2022 CPI basket weight for mortgage interest was just 3.46 per cent. But multiply that by 30.6 per cent growth, and you add a full percentage point to headline inflation growth. Last week’s report points this out: net of mortgage interest costs, the consumer price index actually rose by just 2.4 per cent — within a hair of the Bank of Canada’s target.

Sadly, few people see this number; and if they do, they likely find it a bit confusing. What makes sense to them is the headline. And headline growth jumping to 3.3 per cent in July is enough to keep their price expectations of where inflation is headed well above the Bank of Canada’s target of two per cent. The bank’s stated task is not just to get prices back in line, but also to tame those expectations.

But there’s a significant risk of overdoing it. Let’s do the math. Given that increases in interest costs won’t be abating any time soon, if the Bank of Canada wants to get headline inflation to two per cent, it would have to drive all other consumer costs down to growth of just 0.9 per cent. This path of action virtually guarantees that more broad categories would be in the disinflationary or deflationary zones.

There’s another possible path. If the consumer price index net of mortgage interest costs was the target measure, the central bank would be satisfied with getting it to two per cent growth. If this were achieved, layering in interest costs would lift headline CPI to roughly three per cent. It might take some clever messaging to manage expectations and price-setting, but it might be worth it. The first path risks a considerable loss of economic activity and employment.

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