Price check: Inflation in Canada

Prices tend to go up over time, and it’s a sign of something happening in our economy—inflation.

Inflation is a measure of how much prices for goods and services are rising over a given period of time. Lots of factors affect prices—how difficult a product is to find, the cost of the labour and raw materials used to make it, and competition among the places selling it, to name a few. But at the most basic level, inflation is about demand and supply. When demand for goods and services is greater than supply, prices tend to rise more quickly.

Inflation measures the big picture

To measure inflation every month, Statistics Canada tracks the prices for a long list—what it calls a representative “basket”—of goods and services. The contents of the basket reflect how much Canadians typically buy of each good or service. The prices of these items add up to a measure of average prices, known as the consumer price index, or CPI.

But the CPI is only an average. We all have our own experience with inflation, based on the exact combination of goods and services we buy. Think about what happens when gasoline prices go up. People who drive will be most affected, but if you don’t have a car, that may not be as big a factor in your spending. Something similar happens at the grocery store. If the price of bread rises faster than the price of potatoes, people who eat a lot of bread are more affected by inflation than those who eat a lot of potatoes.

Since the CPI is an average measure, it represents the big picture of consumer spending across Canada. It is not the only measure of inflation, but it is the most common one, used by businesses, institutions and governments. For example, the rise in the CPI every year influences the raises many Canadians get in their annual salaries or the increases in their pensions.

If inflation is too high or too low, problems arise

The economy works best when inflation is stable and predictable. A company planning its budget for next year makes assumptions about how much the cost of its supplies, its rent and its employees’ salaries are going to go up. When these costs rise, companies raise prices as well.

High inflation means that prices are climbing quickly. Purchasing power—our ability to buy products and services with the money we have—weakens. That’s how high inflation hurts an economy: people can’t buy as much and the economy starts to slow. High inflation can mean that people who have saved for their retirement may find themselves with less money than they expected. Businesses and consumers must spend time and effort trying to protect themselves from the effects of rising costs—such as looking for less expensive replacements for goods or services they need, or buying those things less often.

In extreme cases, high inflation is a symptom of an economy that is out of control. Take, for example, Zimbabwe: a country that has had economic troubles accompanied by very high inflation rates—more than 400% in 2024, according to the International Monetary Fund.1 At that rate, the $3 cup of coffee you bought today would cost $15 a year from now. And if the inflation rate remained at 400%, it would cost $75 the year after that. Such extreme rates of inflation are what economists call hyperinflation.

So, if high inflation is bad, deflation—where prices are falling—must be good, right? Not necessarily. A drop in some prices can boost demand for those items. But a general, persistent fall in prices is usually a symptom of deep problems in an economy. When people lose their jobs, they spend less. When firms experience decreasing sales, they lower prices. People may postpone major purchases because they think prices will continue to fall. As more money is saved, less money is spent, prices fall further, and economic activity shrinks.

Inflation over time

In 1991, the Government of Canada and the Bank of Canada agreed it would be good for Canadians to have low, stable and predictable inflation. This agreement made the Bank responsible for bringing inflation down to about 2% and then keeping it near the middle of a 1% to 3% range.

For a long time, Canadians didn’t pay that much attention to inflation because the Bank was generally successful in keeping inflation close to 2%. In fact, inflation in Canada was close to 2% per year for 25 years until the COVID-19 pandemic hit. Then, in 2022, inflation surged above 8%—the highest it had been since the 1980s. When the economy reopened after the pandemic lockdowns, demand for goods and services surged. Supply was also affected by lingering disruptions to global supply chains. Together, these factors pushed prices up. Many Canadians, particularly those on fixed incomes, struggled.

To bring inflation back down to 2%, the Bank of Canada decisively raised the policy interest rate—the target for the interest rate that financial institutions charge each other when they lend in the overnight market. It worked: we slowed the economy to bring demand and supply back in balance. This took the steam out of inflation. But that experience highlighted exactly how painful inflation can be, and how important it is to ensure that it is low, stable and predictable.

How it works

How does raising or lowering the Bank’s policy rate affect inflation? When inflation is above the 2% target, the Bank can raise its policy rate to bring inflation back down. A higher policy rate prompts banks and other financial institutions to increase interest rates on deposits, loans and mortgages. Higher interest rates can reduce demand by encouraging saving and discouraging borrowing and spending. In response, companies increase their prices more slowly or even lower them to encourage demand. This reduces inflation. Lower interest rates work in the opposite way and can help stimulate the economy and encourage demand if it is too low.

Of course, the Bank doesn’t respond to every movement in inflation or focus on prices that jump around a lot. The Bank focuses on price changes that are more widespread and persistent—ones that could push inflation away from the 2% target for a while. This is because any changes the Bank makes to the policy interest rate will take time to affect people’s spending.

The secret of inflation targeting’s success is that it works best when people’s behaviour reinforces the inflation target. If people expect that prices will rise, on average, by about 2% each year, employers and workers are more likely to agree to a 2% wage increase to compensate for the higher cost of living. And since wages affect the cost of producing goods and services, and that cost affects the prices of those goods and services, this cycle helps the Bank keep inflation on target.