A Mainstream Inflation Contradiction

The Financial Post has published an article entitled “Why Canada’s policymakers may want a weaker loonie.” It is a fine testament to the sad state of economic analysis by the mainstream media.

Plate-n-Loonie First, the author informs us that “inflation is weak – and could get weaker – and that has helped push the dollar lower.” This, of course, is preposterous. In this context, inflation refers to the level of consumer prices. It is also indicative of the dollar’s purchasing power. Relatively speaking, “strong” inflation, characterized by higher consumer prices, necessarily means that the purchasing power of the dollar, and therefore its value, is lower than during times of “weak” inflation. Properly defined, inflation is an increase in the money supply, resulting in more dollars chasing existing goods. This bids up prices for existing goods. As a result, other things the same, inflation decreases the purchasing power of the dollar, both in terms of goods and foreign currencies.

Next, after mentioning the possibility of a future rate cut in the Bank of Canada’s target for the overnight rate, we are reminded that “lower rates, however, would be a last-resort scenario to pressure the dollar lower.”

Let’s consider the implications of this statement further. The primary tool used by the Bank of Canada to effect monetary policy is the setting of the target for the overnight rate. Simply put, this specifies the rates of interest that major financial institutions will be charged for loans and paid for deposits by the central bank. As a result, Canada’s big banks, which routinely borrow and lend money overnight among themselves, have no reason to transact outside of this range (called the “operating band”) set forth by the Bank of Canada. This facilitates credit expansion. The central bank is, after all, the lender of last resort.

By setting the target for the overnight rate, the central bank is therefore able to steer interest rates in the broader economy higher or lower. This reverberates throughout the economy, affecting everything from the prime rate of interest of commercial banks to mortgage rates and the interest paid on savings and other investments.

Additionally, artificial interest rate adjustments influence the behaviour of individuals in the economy. Specifically, the lowering of interest rates by central banks increases time preferences, resulting in more consumption, borrowing and spending. It also induces the business cycle, characterized by repeating periods of bubbles and busts. As Ludwig von Mises observed: “The cyclical fluctuations of business are not an occurrence originating in the sphere of the unhampered market, but a product of government interference with business conditions designed to lower the rate of interest below the height at which the free market would have fixed it.” Not surprisingly, inflation, both in terms of credit expansion and the level of consumer prices, is a characteristic feature of this bubble period.

So, according to current economic analysis in the mainstream media, inflation increases the value of the dollar. Also, it decreases it.

Translation: “You can have your cake and it, too, as long as it costs more.”

(Photo Credit: krisclip)

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  • About Gregory Cummings

    Gregory Cummings writes about Canadian monetary and economic policy. His writing has been featured at the Ludwig von Mises Institute of Canada and the Ludwig von Mises Institute's Mises Daily publication. Read more.

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