Where do these inflation numbers even come from anyway?

We're all obsessing over inflation right now, but where do these inflation numbers come from - and how can we make sense of them?

In this first month of the The Data Room, we’re starting slow and exploring the meaning of some well known numbers before we start to dig into deeper SMB trends. If hard data is your thing, subscribe and stay tuned!

The Bank of Canada is expecting inflation to decrease to 3% in 2023, right now that’s looking pretty optimistic considering both Canada and the US are at 40 year highs. You know things are confusing when almost every expert in a field has a different opinion, but how many of us plebs have a firm grasp on what inflation actually is? Part of the problem is that inflation isn’t a phenomenon with a single standard form of measurement. This can make it hard for us to localize a global issue: inflation in the US is different from inflation in the EU which is different from inflation in Canada.

The current state of inflation
As the demand for goods and services grows in an economy the prices naturally rise, by keeping demand and supply at stable levels we can expect a steady rate of inflation. Back in 1979 when the US had 11.25% inflation one of my favourite economists Chaucy Gardnier put it like this: “In the garden, growth has its seasons. First comes spring and summer, but then we have fall and winter. And then we get spring and summer again.” The idea is that inflation is cyclical and can take some time to cool off, considering we’ve been in the 0.1% to 3% range for the last 30 years, it’s no surprise the last few years of turmoil has brought about this much financial calamity. Both Canada and the US have determined that the ideal rate of inflation is around 2% per year, and the Bank of Canada says we’ll be back on track by 2024. In 2022 the inflation rate in Canada was 6.8%, and 8.3% in the US, so does that mean that Canada is dealing with about 20% less inflation? Not necessarily, but more on that later.

How inflation is calculated
Countries use something called the Consumer Price Index to track and measure the growth or decline of inflation. The CPI measures the expenses of Canadians, and tracks how prices of goods or services change over time. Most, but not all, things you buy are indexed, measured, and tracked by the Bank of Canada. Whether you purchase a new home, use financial services, or get that new canoe with your saved up Canadian Tire cash, your total spend is compared against what others have spent over the course of the last 12 months on similar items. The Bank of Canada uses 3 methods when measuring CPI: trim, median, and common. Trim removes the top and bottom 20% of items in the index that have received the most or least inflation, and finds the average of the remaining 60%. Median determines inflation by finding the change in the 50th percentile of the index. Common essentially uses the year-over-year change of all items to make an estimate of the current rate of inflation. These three methods all have their pros and cons, but when used together can provide a more detailed analysis of what the current rate of inflation is.

Canada and the US, both have their own special brand of inflation
Canada and the US both use CPI to track inflation over time. Due to our close trade relationship, and just like that roommate that used to borrow all your clothes, we have agreed upon very similar methods of measurement. However, there is still a factor that can undermine the results: both countries independently determine what groups of products or services actually end up in the CPI. CPI doesn’t track absolutely everything, and sometimes there is a good reason for removing items, such as wild price swings or inability to gather enough information. One of the more talked about examples of this over the last few years was Canada’s former lack of a used car segment in its index, used cars in particular have accounted for a considerable increase in the US’s overall inflation calculation, and many argue that Canadian inflation is higher than actually reported due to inaccurate inclusion and weighting of specific segments. Used cars in Canada were a 44 billion dollar segment in 2019, new cars sales were worth 80 billion, and the CPI category “passenger vehicles” had accounted for 6% of the total CPI. Canada has since changed its catalog and added “purchase of new passenger vehicles” and “purchase of used passenger vehicles” segments which account for a combined total of 5.9% in 2021. Is this cherry-picking? Some might say so, but there are also some legitimate reasons why indexes should look different depending on which country they’re coming from. I was going to throw in an example like “Canadians wouldn’t need ice cream in the winter” until I learned that Canadians eat more ice cream in the winter, but I’m sure you catch my drift.

Inflation impacts small businesses
Steady predictable inflation is easier for almost everyone. It makes borrowing money much less risky because you have a good idea how the value of that loan will change over time; as inflation increases, borrowing costs will increase. Certain sectors do well in periods of high inflation, consumers depend on staple products when money gets tight. However, if your business isn’t inflation-proof, it’s always good to think of ways you could pivot or wait out the storm.  

  

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