MARKET ENVIRONMENT - INFLATION

1. Introduction

An analysis of the inflation rate of the province of Newfoundland and Labrador was made,
based on the official information published online and considering the variation on the
Consumer Production Index of goods and services through the last 28 years.

2. Inflation – Newfoundland and Labrador

As a basic definition, Inflation is an increase in the level of prices of the goods and services that
households buy. It is measured as the rate of change of those prices, from the buyer’s
perspective. The most well-known indicator of inflation is the Consumer Price Index (CPI), which
measures the percentage change in the price of a basket of goods and services consumed by
households.

In the specific case of Newfoundland and Labrador, Chart 1 illustrates the official data related to
the behavior of the inflation rate, based on the CPI index of goods and services, from 1990 to
2017.

Chart 1. Variation in the inflation rate of Newfoundland and Labrador, 1990 - 2017
(Newfoundland and Labrador Statistics Agency)

5
Inflation rate (%)

0
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017

Year
Source: Newfoundland and Labrador Statistics Agency
By the end of October 2018, the annual inflation rates reached 2,13% (compared to values of
October 2017), following the decrease trend compared to 2017 and 2016 figures (2,4% and
2,7% respectively). During the last 5 years, inflation rate has varied in 12,11% more respect to
2014 value, after which the trend seemed to be continuously repeated but at this time reaching
levels below 1% in 2015 (0.5%).

High inflation rates during the 90’s were mostly related to a depressed economy that was
followed by the collapse of the Cod fishery, that marked the largest industrial closure in
Canadian history, and affected deeply Newfoundland inhabitants and its economy. After the
energy boom, the province started to recover rapidly and, during the last 20 years, the inflation
rate has oscillated between 0,2 % (lower point in 1998) to 3,4 (peak reached in 2011).

Chart 2 shows the behavior of the inflation rates during 2018 based on the CPI index of all items,
along with a comparison of the contribution of each item to the monthly inflation rate.

Chart 2. Average inflation rate in 2018 by major component, January – October 2018
(Government)

Services
Goods
Energy
All-items excluding energy
All-items excluding food and energy
Alcoholic beverages and tobacco products
Recreation, education and reading
Health and personal care
Transportation
Clothing and footwear
Household operations, furnishings and equipment
Shelter
Food
All-items

-2.00% 0.00% 2.00% 4.00% 6.00% 8.00% 10.00%

Source: Statistic Canada. Table 18-10-0004-01 Consumer Price Index, monthly, not seasonally adjusted

As shown, the major contribution of the inflation rate is the change in the energy CPI during
January - October, as a result of the increase of the oil prices which increase the price of fuels
and commodities. On a year-over-year basis, growth in the Consumer Price Index (CPI), or
inflation, was 1.61% in the first ten months of 2018. Higher prices for fuel oil and electricity
compared to 2017 exerted upward pressure on the CPI. However, the lowering of the provincial
gas tax on June 1, 2017 and again on December 1, 2017 has mitigated the impact that rising
crude prices had on year-over-year gasoline price growth. For the year as a whole, inflation is
expected to average 2.1%, and by the end of 2020 it is expected that the inflation rate keeps
rounding 2%. (Government of Newfoundland and Labrador, 2018).

3. Inflation of NL vs. Canada’s inflation rate

When compared historical data of CPI change in Newfoundland and Labrador with country data
(Chart 3), it is observed similar trends and variations year over year, with values slightly higher
over the average inflation rate of Canada as a whole. Some of the differences are related to
general change in taxes of products (such as change in the sales tax) or specific taxes of
products such as gasoline, alcohol or cigarettes. Also, a surge in economic growth can lead to
higher inflation in certain provinces more than others, which equalize the overall inflation rate
of the country that has varied between 0.3 and 2,9 % and has kept relatively stable during the
last 20 years.

Chart 3. Comparison of the inflation of Newfoundland and Labrador with Canada inflation, 1990
- 2017 (Government)
7
Annual Inflation rate (%) - Newfoundland and
6 Labrador
Annual Inflation rate (%) - Canada
5
Inflation rate (%)

0
1996

2013
1990
1991
1992
1993
1994
1995

1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012

2014
2015
2016
2017

Year
Source: Statistic Canada

If the behavior of last ten months is reviewed, and considering the contribution of each item in
the overall changes in CPI, Table 1 shows how the percentages are compared.
 Table 1. Comparison among CPI inflation rates of Newfoundland and Labrador / Canada
(Government)

% inflation rate (Jan-Oct 2018)

Products and products groups
Canada NL
All-items 1,82% 1,61%
Food -0,07% -0,55%
Shelter 1,65% 3,34%
Household operations, furnishings
1,31% 0,40%
and equipment
Clothing and footwear 6,00% 1,02%
Transportation 1,53% 2,51%
Health and personal care 0,96% 0,33%
Recreation, education and reading 3,85% 1,19%
Alcoholic beverages and tobacco
3,98% 2,51%
products
All-items excluding food and
2,06% 0,93%
energy
All-items excluding energy 1,70% 0,75%
Energy 2,63% 8,35%
Goods 1,00% 1,64%
Services 2,44% 1,40%

Based only within the January – October period of 2018, the drivers that led inflation to rise in
Newfoundland and Labrador were mainly the energy value, affected by the high fuels prices.
When analyzing the inflation rate of all items excluding energy, it is possible to see that the
inflation rate within the same period of time is reduced to 0,75%, having the transportation,
shelter and alcoholic beverages/tobacco products as the values that affect directly the rates.
However, the country shows a very different behavior; being the clothing and footwear the
major contributor to the inflation rate.

4. Drivers of inflation
Many economists distinguish between two types of inflation: Demand-Pull Inflation and Cost-
Push Inflation. Both types of inflation cause an increase in the overall price level within an
economy.

Cost – push inflation refers to rising costs of production (usually in the form of
wages) contributing to increasing pricing pressure. One of the signs of possible cost-push
inflation can be seen in rising commodity prices, as commodities like oil and metals are major
production inputs.

Wages also affect the cost of production as the single biggest expense for businesses. Analysts
and policy makers currently see the labor market, through the unemployment rate, as the most
important production input. As shortages in labor can create pressure to raise wages, it flows
naturally that the lower the unemployment rate, the higher the possibility of labor shortages.

On the other hand, Demand-pull inflation occurs when high demand causes rising prices, and
can be caused by factors such as the following:

 Expansionary fiscal policy. By lowering taxes, governments can increase the amount of
discretionary income for both business and consumers. Businesses may spend it on
capital improvements, employee compensation or new hiring, among other things.
Consumers may purchase more nonessential items. Furthermore, as the government
stimulates the economy by increasing its spending, say by undertaking major
infrastructure projects, the demand for goods and services will increase, leading to price
increases.

 Devaluation of the currency. Currency devaluation can lead to higher exports (as our
goods become suddenly less expensive and thus more attractive to foreign buyers) and
this increases aggregate demand for our goods and services. Higher demand can lead to
high prices. Currency devaluation can also result in lower imports (as foreign goods
become suddenly more expensive to purchase with devalued dollars).

 Expansionary monetary policy. Through open market operations, central banks can
increase the money supply and create a surplus of liquidity that can bring down the
value of money vis-à-vis the price of goods. In other words, by expanding the money
supply, the purchasing power of all the participants in an economy increases, leading to
a rise in aggregate demand. If the supply of goods does not adjust with this excess
demand, then there will upwards pressure on prices. (Investopedia, 2018)

While the differences in inflation noted above may seem simple, the cause of price level
changes observed in a real economy are often much more complex. In a dynamic economy it
can be especially difficult to isolate a single cause of a change in the price level. For the
particular case of Newfoundland and Labrador, it is noted the combination of both types of
inflation. A cost- push inflation caused by the rise of energy prices (as it’s reflected in the
contribution of the energy CPI variation in 2018) that is followed by the rise in the cost of
transportation due to the same reason. On the other hand, Demand-pull inflation can be seen
by the change in CPI of the Alcoholic beverages and tobacco products (due to change in tax
policies), and the increase of shelter prices due to higher mortgages interests rates.

5. Implications

Many governments have set their central banks a target for a low but positive rate of inflation.
They believe a persistently high inflation can have damaging economic and social consequences:

a) Income redistribution: One risk of higher inflation is that it has a regressive effect on
lower-income families and older people in society. This happen when prices for food and
domestic utilities such as water and heating rises at a rapid rate.

b) Falling real incomes: With millions of people facing a cut in their wages or at best a pay
freeze, rising inflation leads to a fall in real incomes.

c) Negative real interest rates: If interest rates on savings accounts are lower than the rate
of inflation, then people who rely on interest from their savings will be poorer. Real
interest rates for millions of savers in the UK and many other countries have been
negative for at least four years

d) Cost of borrowing: High inflation may also lead to higher borrowing costs for businesses
and people needing loans and mortgages as financial markets protect themselves
against rising prices and increase the cost of borrowing on short and longer-term debt.
There is also pressure on the government to increase the value of the state pension and
unemployment benefits and other welfare payments as the cost of living climbs higher.

e) Risks of wage inflation: High inflation can lead to an increase in pay claims as people look
to protect their real incomes. This can lead to a rise in unit labor costs and lower profits
for businesses

f) Business competitiveness: If a country has a much higher rate of inflation than others for
a considerable period of time, this will make its exports less price competitive in world
markets. Eventually this may show through in reduced export orders, lower profits and
fewer jobs, and also in a worsening of a country’s trade balance. A fall in exports can
trigger negative multiplier and accelerator effects on national income and employment.
 g) Business uncertainty: High and volatile inflation is not good for business confidence
partly because they cannot be sure of what their costs and prices are likely to be. This
uncertainty might lead to a lower level of capital investment spending. (Riley, 2018)

Overall, a high and volatile rate of inflation is widely considered to be damaging for an economy
that trades in international markets. But for the particular case of Newfoundland and Labrador
and Canada as a whole, which in both cases the inflation rate do not exceed 3%, the direct
effect on the economy is relatively weak, affecting mainly the economy of lower income
families.

6. Online footprint

According to the blog “Trading Economics”, Canada's annual inflation rose to 2.4 percent in
October from 2.2 percent in the previous month and above market expectations of 2.2 percent.
“Prices of transportation and shelter led the increase. It was the ninth consecutive month that
inflation has exceeded the Bank of Canada's 2 percent target. Inflation Rate in Canada averaged
3.14 percent from 1915 until 2018”. (Ferreira, Joana, 2018)

It seems that the current inflation rates are being considered very high with respect to other
periods in the past. The portal CBC news remarks “Canada's inflation rate rises to 3%, highest
level since 2011”. The inflation rate rose in every province in July of this year, according to
Statistics Canada; having Newfoundland and Labrador an annual average inflation rate of 2.7%
by July of 2018. (Evans, Pete, 2018)

More specifically, the webpage of the Newfoundland and Labrador Statistics Agency has posted
recently an information where states that Consumer Inflation Averaged 1.8% in first three
Quarters of 2018. “According to the Consumer Price Index (CPI) released by Statistics Canada,
consumers in Newfoundland and Labrador paid 1.8% more for goods and services in the first
three quarters of 2018 compared to the same period in 2017. This Agency have also published
that Energy prices increased during this period by 7.3%, rising across all major sources: Fuel oil
and other fuels up 21.7% and Gasoline up 3.4%, both affected by higher crude oil prices; and
Electricity up 7.4%. Overall consumer prices were 1.1% higher when excluding the Energy
category. All major categories recorded price increases during the first three quarters of 2018.
The highest increases occurred in Transportation, Alcohol and Tobacco, and Shelter, each
between 3% and 4%”. (Economic and Project Analysis Division, 2018)

In an article published by local online newspaper VOCM in May 2017, it was informed that
Newfoundland and Labrador had the highest inflation rate in the country, according to the
latest figures from Statistics Canada. “While the consumer price index shows the annual
inflation rate declined in all four Atlantic Provinces, Newfoundland and Labrador still has the
highest rate at 3.6 per cent, almost an entire point higher than New Brunswick which comes in
second at 2.7 per cent”. (VOCM Local News, 2017)

It is noted that the inflation rates have been analyzed and highlighted recently by local media
and the local Statistic Agency, considering that most of the time the inflation rates of the
province have been usually higher than the average of the country, however they are still within
the parameters established by the Bank of Canada (between 1-3%).

7. Summary – Key notes

 Annual Inflation rate in Newfoundland and Labrador in October 2018 was 2,13%, and has
increased over the last 5 years in 12,11% respect to 2014 figure.

 Inflation rates in Canada have been steady between 1 and 3% during the last 20 years,
with a value for October 2018 that have reached 2,4%, which is significantly high
compared to 2014 (1,9%), 2015 (1,1%), 2016 (1.4%) and 2017 (1.6%) figures.

 Newfoundland and Labrador have inflation rates slightly higher that the values related to
the country, but keep relatively steady according to standards established by the Bank of
Canada. It is expected to keep rates at 2% by the end of 2020.

 Prices of energy worldwide have affected the inflation rates not only in the province of
Newfoundland and Labrador but also in the entire country. However, this effect is not
perceived over the rates of the country as the economic growth in each province may
differ and can compensate those effects.