Staying close to target

The main measure of inflation in Canada is the Consumer Price Index (CPI). But who controls it, what does it measure and who uses it?

The main measure of inflation in Canada is the Consumer Price Index (CPI). But who controls it, what does it measure and who uses it?

The CPI is administered by Statistics Canada. It is an indicator of changes in consumer prices experienced by Canadians. It is calculated by comparing, over time, the cost of a fixed basket of goods and services purchased by consumers. It measures only price changes by tracking the equivalent quality and quantity of the items in it. Items that may be considered luxuries are included and nothing is omitted based on moral grounds. For example, tobacco and alcohol are included because people spend money on them even though some regard them as undesirable.

There are approximately 600 different goods and services in the CPI index. The items are grouped into 175 basic classes. The classes are further aggregated into eight major components:

• food

• shelter

• household operations, furniture and equipment

• clothing and footwear

• transportation

• health and personal care

• recreation, education and reading

• alcoholic beverages and tobacco products.

The overall CPI index that contains all the goods and services is called the all-items CPI index. Statistics Canada also produces separate CPI indexes for each of the major components for Canada as well as for each province, and other special aggregates such as all-items excluding food and all-items excluding energy, among other measures.

According to Statistics Canada, the CPI is used in several important ways:

• It is used to escalate a given dollar value, over time, to preserve the purchasing power of that value. For this reason it is often used to adjust contract payments such as wages, rent, leases, child and spousal support, private pension plans as well as public pension plans such as the Canada Pension Plan and Old Age Security.

• Economists use the CPI for economic analysis and research on various issues such as regional disparities in price movements.

• It is used as a deflator of various economic aggregates, income flows (to obtain constant dollar estimates of income) or expenditure flows (to obtain personal expenditure estimates at constant prices).

• The Bank of Canada, our central bank, also uses it to set and monitor the implementation of monetary policy.


Let’s look into how the bank customizes CPI data for its use.

The key mandate of the central bank is to maintain inflation in the range of 1% to 3%, so 2% is the average target. It uses the 12-month increase in the CPI because it is a broad gauge of inflation that is relevant to Canadians. Since it is looking at long-term stability, it tries to avoid reacting to temporary factors affecting inflation. That’s why it uses core inflation as a measure, rather than the all-items CPI.

The measure the bank used as an operational guide from 2001 to 2016 was the CPIX. The CPIX strips out eight of the most volatile components of the CPI and adjusts the remaining components for the effects of changes in indirect taxes. Excluded items include fruits, vegetables, gasoline, fuel oil, natural gas, mortgage interest, intercity transportation and tobacco products.

In recent years, however, the bank has found that the usefulness of CPIX inflation as an operational guide has deteriorated. According to a recent speech by Lawrence Schembri, deputy governor of the Bank of Canada, it has found large transitory shocks to CPI components not excluded from CPIX, which highlights inherent weaknesses in using CPIX as a measure of core inflation. For example, in a span of one year in the early 2000s, the inflation rate of automobile insurance premiums rose to 30.6% from 2%. At its peak, this one component of the CPI basket was increasing the overall CPIX by a full percentage point. Other items, such as electricity prices, have also shown very high, but temporary, volatility, leading to noticeable movements in CPIX inflation.

As a result of the deficiencies of CPIX, the bank has decided to change the way it measures core inflation. It is replacing CPIX with three new measures of core inflation: CPI-trim, CPI-median and CPI-common. The bank states that the combined new measures allow the underlying data to “speak” and therefore more accurately identify persistent movements in the inflation rate, which allows it to focus on the macroeconomic variables important to monetary policy.

The bank seems to be doing an effective job regarding its inflation mandate. Over the past 26 years it has helped maintain inflation close to its 2% target, with no persistent episodes of inflation outside its inflation-control range of 1% to 3%. This latest change seems a prudent move to ensure its track record continues.