The fight to tame inflation has only just begun

Inflation is decelerating quickly. It peaked at 8.1 per cent last summer. It fell to 5.9 per cent in January, and the Bank of Canada predicts it will fall to three per cent by the end of this year.

But economists say that's the easy part.

The Bank of Canada has repeatedly said it's committed to getting price growth all the way down to two per cent. One of the bank's deputy governors delivered a speech in Calgary on Feb. 16 titled No Two Ways About it: Why the Bank is Committed to Getting Back to 2%.

"If inflation stays above target for a significant amount of time, then high and variable inflation will likely go hand in hand with a less efficient, more distorted economy," deputy governor Paul Beaudry said.

But both the forces that shape inflation and the way we think about it have fundamentally changed. After decades of persistently low inflation, most forecasts show price growth is now set to remain stubbornly high.

A 'struggle' to get inflation to 2%

"Before the pandemic, central banks were really struggling to get inflation up to two per cent," said Bank of Montreal chief economist Douglas Porter. "Now, I think they're really going to struggle to get it down to two per cent."

He said a lot of the forces that were keeping inflation low have "run their course" — pointing primarily to globalization and tech.

"Globalization, at best, has stalled out. I think, at worst, it might even be going into reverse," Porter told CBC News. Technological advances also kept pushing prices lower, but they, too, are likely starting to ebb, he said.

"I wouldn't say it's over, I just don't think it's quite as helpful. You know, for instance ... Amazon's effect on retail prices is probably largely baked in there now."

Economists like Frances Donald agree. She's the global chief economist at Manulife Investment Management. And she's been warning about this for years.

"A lot of the pressures on inflation were actually in process before the pandemic hit," Donald told CBC News.

She said deglobalization has made international trade more expensive, changing climate risks have made food production more volatile and supply chains have become more vulnerable.

"If you run through the list of the structural pressures on inflation ... you'll find that very few of them are sensitive to domestic interest rate policy, especially in Canada," Donald said.

Consumer expectations upended

The other major factor in all of this is consumer expectations.

For all those years of low, stable inflation, consumers had a pretty entrenched sense of what things should cost and how much their wages should rise to keep up.

Now, that balance is out of whack.

In his Calgary speech, Beaudry said when inflation is low and stable, consumers have a natural reaction when prices rise. They go in search of a better deal.

"If people don't believe they can find a better price by shopping around, firms have more leeway to increase markups, leading to distortions that make the economy less efficient and consumers worse off," he said.

Porter said we are seeing elements today as the economy gets used to price increases.

"I believe that the psychology has changed here a bit as a result of the last couple of years," he said.

That change in psychology, he said, applies to both consumers and businesses.

"I think businesses have learned that hey, you can get away with the price increases, and consumers have become a little bit more tolerant of it," Porter said. "I think [Bank of Canada governor Tiff Macklem] would be rolling his eyes if he heard me saying all this. But I actually do think the dam is broken a little bit on that front."

All told, the forces that once kept inflation low and stable are now combining to keep price growth high. So, some say, we will need to adjust our responses.

"We're going to have to acknowledge — particularly as inflation likely stays somewhat higher than it has historically — that trying to use monetary policy to solve all of our inflationary woes is misguided," Donald said.

Interest rates can only do so much, she said, and won't change those global forces such as climate, deglobalization and weakened supply chains.

Bank of Canada reviews target every 5 years

Donald said the central bank formally targets a range of between one and three per cent, with the target of two per cent in the middle. She thinks it will have to consider nudging that target up to the higher end of the range or consider using longer-term measures that allow for periods of higher inflation.

The Bank of Canada reviews its target every five years. The last review was completed in December 2021. That was, of course, a very different time. Back then, the bank said its first consideration was that "interest rates around the world are lower than in the past. And they'll likely stay low in the future."

Since then, inflation took off, and central banks everywhere aggressively hiked interest rates to get prices back under control. The renewed framework will stay in place until 2026.

No one is suggesting the bank change that framework now.

"Unfortunately, now is not the time to be adjusting that target," Porter said. "You can't move the goalposts in the middle of a battle like this."

Donald said that right now, the Bank of Canada needs to focus on the task at hand, which is getting inflation down from where it is. But once the dust settles, she said, the bank will have to take a long, hard look at how it thinks about inflation in the long term.

"My sense is that the next several years will be one of intense self-reflection for central banks in which they have to assess just how much control they have over their government's given mandate," she said.