Mitch Heimpel: Our inflation expectations are a problem

Our financial experts did a disservice by managing expectations with promises that inflation would be transitory

By: Mitch Heimpel

We have no idea how to talk about inflation in this country.

In part, it’s because we keep talking past each other. Whether it's about quantitative easing, or supply chains, or the first major international oil and gas supply crisis since the 1970s, one thing we're not talking about is our expectations. 

And, as has been noted in this space previously, it's actually our expectations that are the problem — with inflation almost as much as anything else. 

It's hard to get past elite failure in the creation of this mess. Starting in the summer of 2021, Bank of Canada Governor Tiff Macklem and his Federal Reserve counterpart Janet Yellin started using the word "transitory" when they talked about inflation. It was here, but it would pass. It was a kidney stone working its way through the economy. That's a decent metaphor for supply chain disruptions in a way, right?

The thing is, they probably knew it wasn't transitory. There wasn't a short-term fix to the supply chain problems. There was an element of high demand in the economy that was, in fact, caused by high levels of disposable income caused by pandemic support programs. It's perfectly okay, even routine, for huge public policy problems to have multiple causes. It makes no sense that we've been debating whether supply chains or monetary policy led to inflation. It can be both. It likely is those two factors, in addition to the aforementioned pressure on oil prices and a Canadian housing crisis a generation in the making. 

But what they also knew was that inflation that leads to increased inflation expectations in the economy can take an economic datapoint and turn it into a full-blown crisis if those expectations aren't managed. When you look at it that way, it's easy to understand what Macklem and the Bank of Canada were trying to do with their ongoing odes to the transitory nature of inflation. The problem was, once they said that inflation was transitory, they also had to act like it. You can't increase interest rates if you don't believe the state of the economy either calls for it, or can handle it. 

Inflation expectations, simply put, are the result of a belief in the economy that prices will continue to climb and that pressure will be put on wages to keep up (The Brookings Institute has a more complex definition here). If you don't manage inflation expectations properly, you end up somewhere in the late 1970s. Former Bank of Canada Governor David Dodge gave an interview to the Globe and Mail's David Parkinson last week warning about our inflation expectations. "The issue for central banks is very much that they need to be careful not to let the expectations genie out of the bottle..."

Once again, our elite financial class is a little behind the crisis here. 

Wage expectations are baking into the economy all over the place. Public- and private-sector negotiations all over the country from government workers in P.E.I., grocery workers in Ontario and Quebec to public-sector janitorial staff are seeing massive and in some cases, record wage increases. 

If our financial elite think they're still fighting a battle over inflation expectations, then they're still fighting the last war. They're still not ahead of the problem, and that should worry all of us. Trust in our institutions is at an all-time low. Sure, they've been battered by a lot of foreign and domestic misinformation, but they've done a fair amount of damage to themselves. "Transitory" inflation comes right on the heels of governments that couldn't tell us whether masks were effective at the start of COVID-19, and assured us that "the risk to Canada is low." 

And the less said about the decade that our financial institutions have spent telling us that, first, there was no housing crisis, and then that it was confined to "bubbles" in the Toronto and Vancouver areas, the better.

Ultimately the problem with this kind of elite failure can be distilled down to the fact that our leaders have no faith in the ability of the citizenry to either understand complex problems or act with common purpose. So, it's easier to lie to us. To undersell the severity of a problem to avoid the expense of an actual solution. 

Our inflation expectations are the problem. David Dodge's genie is not only out of the bottle, he's on the second wish by now. Tougher medicine does seem en route for this economy as the Bank, and the Federal Reserve, proceed with interest rate hikes that are unheard of in recent decades. 

That's a heck of a response to a problem that a lot of very smart people assured us was just ... transitory.

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