Exacerbating Canadians’ Financial Stress:
How COVID-19 has Affected Inflation Measurement
Arthur Berger
The method Statistics Canada uses to calculate the Consumer Price Index doesn’t work well when there are big changes in consumer spending patterns, which is exactly what is happening due to COVID-19.
Less Money for Canadians
Erroneously negative inflation data will cause Canadian households to transfer more of their income to government, while causing government to decrease its payments to households. This will push more Canadians out of the middle class and into low income. Those who remain in the middle class (and in high income) will pay more tax than they would if the CPI accurately reflected the change in the cost of living. This unintended, and inappropriate, drag on the economy comes at a time when many new and expanded government programs are intended to help Canadians stay out of poverty.
How Inflation is Calculated
Historically, Statistics Canada’s Consumer Price Index (CPI) has provided an accurate and timely measure of inflation. Unfortunately, the method used to calculate CPI doesn’t work well when there are big changes in consumer spending patterns, which is exactly what is happening due to COVID-19.
Statistics Canada reported that consumer prices in April 2020 were 0.2 per cent lower than they were in April 2019. Excluding energy, Statistics Canada said the Consumer Price Index (CPI) rose 1.6 per cent.
The CPI is a weighted average of the price movements of the entire “basket” of goods and services that Canadian consumers purchase. The CPI uses Canadians’ spending pattern from a previous year (2017) to measure inflation in 2020. This methodology gives far too much weight to items Canadians are buying less of, like gasoline, traveler accommodation, clothing and footwear. It is not a coincidence that lower prices for these items were among the main contributors to the negative inflation number Statistics Canada reported for April. The reason these prices went down is because consumers weren’t buying them very much.
The CPI methodology also does not give enough weight to items Canadians are buying more of due to COVID-19, such as household cleaning products. Prices for these products went up due to increased demand. So, the CPI narrative is that the cost of living went down in April because the prices of things people don’t buy much of anymore has gone down while the prices of things Canadians buy more of has increased sharply. Clearly, this does not make sense.
How Understating Inflation Hurts Canadians
The impact of severely understating inflation is big. According to the Statistics Canada website “the CPI is widely used to adjust contracted payments, such as wages, rents, leases and child or spousal support allowances. Private and public pension programs (Old Age Security and the Canada Pension Plan), personal income tax deductions, and some government social payments are also escalated using the CPI.”
This means people in low income, such as seniors who depend on OAS and single parents who rely on child support payments or government social programs, will not receive the increase in income they need to keep pace with the rising cost of living. Taxpayers will also be adversely affected, as income tax brackets will move in the wrong direction. This will put more income into higher tax brackets even for people whose income did not increase.
Statistics Canada’s Position
I wrote to Statistics Canada’s senior management to express my concerns. Statistics Canada responded to me promptly, making the following points.
Statistics Canada is concerned about potential bias in the CPI due to changing spending patterns.
At this point, nobody knows how long changes in consumption spending will last, nor what additional changes in consumption will happen as the economy reopens.
Statistics Canada will track consumption changes to determine which are temporary and which are of a more permanent nature.
Statistics Canada decided to stick with its methodology after consulting with its “key stakeholders” and on the advice of their Prices Measurement Advisory Committee (a group of external experts/stakeholders).
Statistics Canada’s methods are aligned with its peer agencies, including the US Bureau of Labor Statistics and EuroStat.
Statistics Canada is working with the Bank of Canada on a “COVID CPI” that would help identify potential bias or serve as an alternate inflation measure. Statistics Canada expects to have publicly available information on this in the next few weeks.
The good news is that Statistics Canada can solve this issue by changing the CPI methodology. Here is a list of additional actions I think Statistics Canada should take, as soon as possible, to improve the CPI.
A Call to Action
Make quality the top priority for the CPI
The most important factor influencing the methods used to calculate the CPI should be how well the CPI measures changes in Canadians’ actual cost of living. Therefore, Statistics Canada should create and share a plan to improve the CPI by using an indexing method that makes equal use of prices and quantities in both the current period and the prior period to which current prices are being compared. This is the method experts generally agree is best. Statistics Canada should not be guided by methods used in other countries if those methods are not close to being as good as other alternatives in terms of quality and practicality.
Be more transparent about short term plans for the CPI
Because Statistics Canada is currently using a fixed-weight method, they don’t want “temporary” changes in consumption to influence the CPI weights. This being the case, Statistics Canada should be transparent about:
how it will track consumption patterns,
what criteria will be used to determine if a consumption change is of long enough duration that it should be accounted for in the CPI basket weights,
what action Statistics Canada will take if consumption changes endure long enough to be considered non-temporary.
If Statistics Canada decides to stick with a fixed-weight approach for several years, it should publicly commit to not using an unusual year, such as 2020, to determine the consumption pattern for the next update of its basket weights. Using 2020 to determine basket weights would quite likely cause inflation to be understated by CPI as consumption moves into a new normal pattern following the pandemic.
Be more transparent about decision making and governance
All public entities should be transparent and accountable to the public. After all, these entities are funded by taxpayers and exist to serve the public. Statistics Canada could improve its transparency by putting all documents / records associated with advisory committee meetings, and consultations with stakeholders, other statistical agencies and international organizations on its website. Statistics Canada should also post, on its website, information about how it identifies stakeholders, how it decides what advisory committees to create, how it determines membership of its advisory committees, and how the terms of reference for advisory committees are established and maintained over time.
What You Can Do
If you want this problem to be corrected, I encourage you to take the following actions.
Use the Statistics Canada on-line form to express your concern.
Contact your Member of Parliament (MP) and share you concerns. You can use this link to find out who your MP is and how to contact him / her.
Share this post with other people who care about the financial well-being of Canadians.
Arthur Berger, Contributor
Arthur Berger retired in 2019 after 8 years as the head of data and statistics at the Bank of Canada. Prior to that, Arthur worked at Statistics Canada for 24 years.
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Technical Stuff
Statistics Canada calculates the CPI by comparing, over time, the cost of a fixed basket of goods and services purchased by consumers[i]. The Statistics Canada website says the CPI basket shares are updated at two-year intervals[ii]. This appears to be true from 2011 to 2017. Statistics Canada has not, however, updated the basket shares since 2017.
Chapter 8 of Statistics Canada’s The Canadian Consumer Price Index Reference Paper says “While there is no rule as to how often a CPI basket should be updated, there is general agreement among CPI compilers that more frequent basket updates are preferred”[iii].
The International Monetary Fund (IMF) publishes The Consumer Price Index Manual, Concepts and Methods[iv] which is an international standard intended to guide national statistical agencies on how best to calculate the CPI. The following is an excerpt from page 24 of the IMF manual.
D. Overview of the CPI Concepts
1. Type of index number formula
1.11 Experts generally agree that the ideal type of index for a CPI would be a “superlative” index such as the Fisher index, which will be discussed below and in Chapter 8. Superlative indices make equal use of the prices and quantities (i.e., the expenditure weights) in both periods being compared (the reference period and the current period). Current period expenditure weights are usually not known, so in practice nearly all CPIs rely on weights relating to a weight reference period some time earlier. An exception to this are actual transactions that can be captured at the points of purchase through the use of scanner data (as discussed in Chapter 10).
The key point is the IMF recommendation of making equal use of prices and quantities in both the current period and the prior period to which current prices are being compared. The IMF manual mentions that current period expenditure weights are usually not known, but explains the use of retail checkout scanner data would provide the needed data. When I was the head of statistics at the Bank of Canada, I worked closely with Statistics Canada regarding improvements to the CPI that are important to the Bank. I know that Statistics Canada has retail checkout scanner data from some retailers. I believe Statistics Canada could get this data from enough retailers to implement the IMF’s recommendation.
[i] https://www23.statcan.gc.ca/imdb/p2SV.pl?Function=getSurvey&SDDS=2301
[ii] https://www23.statcan.gc.ca/imdb/p2SV.pl?Function=getSurvey&SDDS=2301
[iii] https://www150.statcan.gc.ca/n1/pub/62-553-x/2015001/chap/chap-8-eng.htm