Currently, we are in stagflation which is a prolonged period of slow economic growth, high unemployment, coupled with a positive inflation rate resulting in decreased buying power.
Prior to the 1970s, economists thought it was impossible to have both a stagnant economy and high inflation. Historically, when unemployment was low, inflation increased, and when unemployment was high, inflation decreased.
But now we are being affected by powerful global economic forces that can throw inflation into an upward spiral.
Ideas from economist Milton Friedman (1912–2006) have been used to correct stagflation. His formula to solve the problem of stagflation was to raise interest rates and limit the amount of money in circulation. For the first time in Canadian history the government has removed a coin from circulation, the penny.
Accurately predicting both the short and long-term performance of the economy is difficult. If the government raises interest rates too soon, it could shut down a restarting economy. If it waits too long, the economy can become overheated with extra cash, causing prices to rise and inflation to soar which is where we are headed.
Mark Hopkins, the senior Canadian economist for Moody’s said:
“The federal government, focused on eliminating the budget deficit before the end of 2016, is not likely to engage in aggressive economic development plans, and cash-strapped provincial and local governments, confronting deficits of their own and rising long‐run costs of health care, have little room to do so either. Managing inflation across the western and eastern halves of the country will also be a challenge for monetary policy makers at the Bank of Canada, as the distance between the Western and Atlantic provinces limits labour mobility.”
The Bank of Canada conducted research into the possibility of targeting a lower inflation rate, switching to price-level targeting, or formally adding financial stability as a target of monetary policy. It opted against any of these.
Inflation is a two-edged sword. A little bit might be a good thing, but then how do you keep it at a little bit and not go beyond that?