What is inflation and why is it so high?

May 25, 2024 Insight from Eric Van Enk, Wealth Advisor & Associate Portfolio Manager

When I speak with clients or meet readers of my articles around town, I often receive questions about inflation – what is it and why is it so high? Inflation is a measure of how quickly prices for goods and services increase (or decrease in the case of deflation) over time. Inflation can also be defined through the concept of purchasing power – what you can purchase for $100 at the grocery store today is substantially less than only a few years ago. From an economics standpoint, inflation is neither good nor bad, it is simply a measure of how the prices of a basket of goods and services changes over time. Inflation becomes either ‘good’ or ‘bad’ based on how it impacts the economy and individuals’ lives.

Why do central banks like the Bank of Canada try to maintain inflation near two percent? Two percent is somewhat arbitrary, however, the key is economies function the best in a goldilocks scenario where inflation is neither too hot nor too cold. Japan represents a recent example of the negative economic impacts of low inflation / deflation. If inflation is too low or negative (deflation), consumers aren’t incentivized to spend money – why would I buy a television today if I know it will be cheaper next month? Consumer spending on goods and services represents a significant portion of the economy, thus, low inflation / deflation is negative for economic growth.

At the other end of the spectrum, there are many historic examples of economic disasters created when inflation is too high – post-war Germany, several periods in Argentina, etc. Hyperinflation (very high inflation) is typically caused by large government deficits that encourage the printing of money to repay debt. However, inflation doesn’t need to reach ‘hyper’ levels to cause damage. Consider the impact inflation has had on the Canadian economy and society since COVID. It’s clear the ‘have nots’, the poor, the lower-middle class, and the youth have been hurt the most by high inflation. The reason is because these groups don’t own enough assets to benefit from inflation. If you own a house, a cottage, rental property, an investment portfolio, etc., all those assets have increased in value and kept pace with inflation. In many cases, the wealthy and upper-middle class have benefited from higher inflation due to the increase in the value of their assets overwhelming the negative impact of the increased cost of the goods and services they consume.

One of the reasons government deficits contribute to inflation is known as the crowding out effect. If governments run large deficits to pay for expanded government programs like the current federal government is doing, they need to hire additional employees to administer those programs. This creates competition for labor with the private sector which leads to inflation in the labor market. For example, if an employee is making $60k per year at a private sector job and now the government is hiring for a similar role with the added benefits of a pension plan and additional vacation time, how much more does the private sector employer have to pay to keep that employee?

This, in my opinion, is one of the great ironies of our time – the federal government is hurting the groups it ostensibly wants to assist – the poor, the youth, the ‘have nots’ by running historically large deficits which are contributing to inflation.

Source: National Bank Financial

The supplied chart shows the breakdown in inflation between food & energy (red), services (grey) and goods (dark blue) in the U.S. As is the case in Canada, the U.S. is running massive budget deficits (~6% of GDP). Running this large of a deficit without being in a recession is unprecedented and is contributing to inflation staying above the Federal Reserve’s two percent target. As you can see, current inflation is comprised almost entirely by services inflation which is driven by labor costs (labor is the largest component of the cost of a service).


Eric Van Enk, Wealth Advisor & Associate Portfolio Manager

National Bank Financial – Wealth Management

Medicine Hat, AB

National Bank Financial - Wealth Management (NBFWM) is a division of National Bank Financial Inc. (NBF), as well as a trademark owned by National Bank of Canada (NBC) that is used under license by NBF. NBF is a member of the Canadian Investment Regulatory Organization (CIRO) and the Canadian Investor Protection Fund (CIPF), and is a wholly owned subsidiary of NBC, a public company listed on the Toronto Stock Exchange (TSX: NA). The information contained herein has been prepared by Eric Van Enk, Associate Portfolio Manager and Wealth Advisor at NBF.  I have prepared this article to the best of my judgment and professional experience to give you my thoughts on various financial aspects and considerations. The opinions expressed herein, which represent my informed opinions rather than research analyses, may not reflect the views of NBF. The opinions expressed are based on my analysis and interpretation of historical data. Values and returns will fluctuate, and past performance is not necessarily a guarantee of future performance. The particulars contained herein were obtained from sources I believe to be reliable but are not guaranteed by me and may be incomplete. The opinions expressed are based upon my analysis and interpretation of these particulars and are not to be construed as a solicitation or offer to buy or sell the securities mentioned herein. The securities or sectors mentioned herein are not suitable for all types of investors. Please consult your wealth advisor to verify whether the securities or sectors suit your investor's profile as well as to obtain complete information, including the main risk factors, regarding those securities or sectors.

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