Canada’s central bank has been going Brrr, and it’s not because of the frigid winters in Ottawa. Bank of Canada (BoC) data shows that the money supply is still expanding rapidly in October. The M2++ money supply hit peak annual growth last year, reaching the highest level since the 1980s. The latest numbers show over 1 in 5 Canadian dollars today, didn’t exist prior to 2020. Traditionally the expansion of the money supply precedes inflation. That explains a lot.
Canada’s M2++ Broad Monetary Supply
The M2++ is a broad measure of the money supply and includes the bulk of “money” in Canada. It includes cash, bank accounts, and other retail instruments. We’ll circle back to what the M2++ data might mean in just a second, but first, let’s go over the numbers.
Canada’s M2++ Money Supply Hit A 1980-High For Growth
Canada’s broad money supply (M2++) has been expanding rapidly. In October, it reached $4.28 trillion, up 9.9% from the year before. Recent peak annual growth reached 14.4 % in February 2021, and it was the biggest surge since May 1980. That preceded the last inflation crisis, so it’s been a minute since we’ve seen this kind of growth.
Over 1 In 5 Canadian Dollars Didn’t Exist Before 2020
The persistently high growth is a surreal event. Since January 2020, the money supply has grown a whopping 22.2%. Over 1 in 5 dollars in Canada’s broad money supply didn’t exist before 2020. Just the expansion over the past two years is larger than all money in Canada prior to 1996. This is an unbelievable amount of growth.
Soaring M2++ Money Supply Growth Often Precedes Inflation
What does this mean? It’s hotly debated, with some arguing the expansion of the money supply means nothing. Just a trillion, no one will know, right? Other prominent economists say the expansion of the money supply is behind recent “asset bubbles.” It also happens to be a position held by many at the Bank of Canada (BoC). One report notes, “persistent deviations of money from long-run money demand are associated with significant changes in inflation.”
Money is a store of value, and while it might not find its way into the economy immediately, it eventually will. “Broad money should provide leading information about future spending and, hence, about inflation,” writes the BoC in another report.
The same report shows the two-year growth rate of M2++ is closely related to the 2-year rate of CPI. “M2++ has also been found to be a useful predictor of inflation over a horizon of one to two years,” says the BoC.
In plain English? The 2-year growth is a solid indicator of future inflation. Let’s see what this looks like, shifting the money supply forward by 12-months. This ideally will help us understand where inflation is heading.
Canadian CPI and M2++ Money Supply 2-Year Growth
The two-year growth rate of the Canadian consumer price index (CPI) and the M2++ broad money supply. The M2++ is moved 12-months forward to visualize the impact on inflation.
Source: Bank of Canada; Better Dwelling.
The above model shows inflation running high for another two or three years. Interestingly, the recent BoC Business Outlook Survey shows most businesses expect above-target inflation for a similar length of time. Being close to producer costs tends to provide a lot of insight into retail prices.
Now, that doesn’t mean inflation will run at an elevated level for two years but consider two things. First, the change in CPI methodology will chronically underreport annual growth in the future. We’ve previously outlined how changes to make the basket weights more “dynamic” will lower CPI. A Big Six bank even agreed with this sentiment a few days later.
More importantly, monetary policy intervention is likely to prevent inflation from running its entire course. The BoC is forecast to raise the overnight rate as early as this month to slow inflation. At the latest, most banks see a hike to interest rates in less than three months. Higher rates throttle credit, slowing the expansion of the money supply. The drop in demand is forecast to taper inflation, but it’s anyone’s guess how this plays out with the asset bubbles created.
If the BOC really want to bring inflation under control, they can achieve it by aggressively raising interest rates and pricking all the asset bubbles (including real estate ) like Paul Volcker did in the early 80’s. The question is how committed are they and how much political pressure can they absorb – our governments are loaded with debt that will become much more expensive. Higher interest rates will reveal who has leveraged themselves too thin – we will see who is swimming naked when the tide goes out.
There was a reason Tiff Macklem was passed over first for Mark Carney and again for Stephen Poloz , nobody competent in the wings this time , you should not be promoted just because you hung around long enough. Has anybody asked Carney and Poloz their opinion or is this an old boy code of silence?
Nothing a war with Russia and China can’t fix. They always say war got us out of the depression – they got nothing else.
Beef up the healthcare system (it’s been on the brink of collapse for over a decade), end restrictions, pop the asset bubble. People will move their investments from non-productive real estate into productive businesses through stocks and capital investment. Short-term pain for long-term gain.