Currently, many central banks and authorities are implementing monetary policies to do monetary tightening in response to current inflation and expectations of even higher inflation in the short term. Core inflation is moving up in many countries so many countries are following by tightening their monetary policies to avoid inflation becoming entrenched in their economies.
In US, economic activities have moderated, but labour market is still tight. China and many other countries still face challenges from the pandemic shutdowns, and commodity prices have been volatile where some have moderated, while others like natural gas have increased in price. In Canada, the economy is operating in excess demand and labour market is still tight. The Canadian GDP has grown by 3.3% in the second quarter which was weaker than projected and domestic demand has been strong. Consumption has grown by 9.5% and business investments were close to 12%. There was unsustainable growth during the pandemic in the housing market, but with higher mortgage rates, it's pulling back as anticipated.
The Bank continues to expect the economy to moderate in the second half of this year, as global demand weakens and tighter monetary policy in Canada begins to bring demand more in line with supply.
If growth has dampened across the world and in Canada, why is there such high inflation?
- the increase in consumption has pushed up the aggregate demand in the country and businesses have made more investments given lower borrowing rates during the pandemic and their expectations of increased demand in the future due to the increase in consumption. The current supply is unable to meet this increase in consumption due to disruptions in the supply chain during the pandemic. Because the current supply is unable to meet the consumption increase, prices are starting to go up because of buyer competition. So, the increase in the aggregate demand is starting to create more inflation and this is expected to continue for the short term.
- the increase in prices and inflation might strengthen the speed at which transactions occur, but the increase in prices does not reflect an increase in the real value of the items and the increase in transactions does not reflect real growth. So, real growth is not growing despite the inflation. Because it's not growing, there are fewer goods and services on the market with more buyers, so prices continue to rise in response and inflation grows.
- monetary tightening is expected to slow down demand and thus slow down inflation to make demand meet the current supply and stabilize prices until real growth occurs.
All feedback is appreciated. I'm not sure if my above logic is correct, and I think I need clarity on why real growth is not occurring despite price increases. If there are other ways to think about this, please do share.