Study: The soaring loonie and consumer prices

While it is difficult to estimate the true impact of last year's stronger dollar on inflation, there is evidence that some Canadian consumers did benefit, according to a new study.

The study found evidence that the prices of some goods with a high reliance on the US dollar, such as oil-based products, automobiles and computers, either fell or slowed considerably.

However, the study also showed that the stronger dollar did not have a direct impact on the prices of many items in the basket of goods and services measured by the Consumer Price Index (CPI).

At least half of last year's overall slowdown in the CPI did not appear to be directly linked to the exchange rate. At least one-third of the CPI slowdown appears related to lower world crude oil prices and almost another quarter is from services that have no direct import content.

It is difficult to estimate the true impact of the exchange rate on inflation because of myriad other complex factors at work. During 2003, crude oil prices fell worldwide, quite apart from the impact of the weaker US dollar. Low interest rates also worked to slow down consumer inflation in Canada.

In addition, the decisions of many other players—importers, wholesalers and retailers, among others—are at work in determining the final price of goods and services.

On November 18, 2003, the Canadian dollar hit 77.13 cents US, a 21.7% increase from 63.39 cents US on the same date in 2002. It was the largest 12-month movement, either up or down, in Canada's history.

At the same time, Canada's inflation rate, as measured by the CPI, slowed considerably. In January 2003, prices were 4.5% higher than they were a year earlier. By January 2004, this year-over-year rate of growth had been cut to only 1.2%.

At the outset of 2003, Canadian consumers were experiencing larger overall price increases than their American counterparts. But in the spring, the gap started to narrow as inflation in Canada slowed. By September, prices were rising faster in the United States than they were in Canada for the first time in more than a year.

Gasoline the most important factor in the CPI slowdown

In general, goods with a very high reliance on the US dollar—that is, 40% or more—were responsible for more than one-half of the deceleration in the CPI during 2003.

In this study, the reliance on the US dollar is measured by the proportion of the final price accounted for by the costs of imports from the United States and China, since the Chinese yuan is pegged to the US dollar.

Oil-based products, gasoline in particular, accounted for almost all of this contribution.

The study estimates that gasoline contributed about 43.5% to the overall deceleration in the CPI during 2003.

But at least two-thirds of the deceleration in fuel prices was probably due to world crude prices, not the exchange rate. Prices of Canadian crude oil closely follow world prices, which are negotiated in US dollars. Thus, this study assumes that the crude oil content of oil-based consumer products relies directly on the US dollar.

Up to another one-third of the drop in fuel prices appears linked to the exchange rate. In the 12 months ending January 2004, gasoline prices fell nine percentage points more in Canada than they did in the United States.

Prices of new cars and computers dropped

The prices of goods with a slightly lower reliance on the US dollar, about 30% to 40%, contributed 17.8% of the consumer price slowdown in 2003.

Twelve of the 18 items in this category recorded lower prices in January 2004 compared with January 2003. Prices for the 18 items fell 2.0% on average during the year, after rising 1.5% during the previous 12 months.

The most significant of the 12 items recording lower prices were new cars and computer equipment.

About 10% of the overall deceleration in the CPI was due to lower prices for new cars, which rely on the US dollar for about 38% of their costs.

Computer equipment and supplies accounted for another 3.1% of the deceleration of the CPI in 2003. In January 2004, prices of computer hardware were 16.9% lower than in January 2003. In January 2003, they were 7.1% lower than in January 2002.

It is difficult to pin price declines in either new cars or computer equipment on the exchange rate rather than on other factors.

A few months after the Canadian dollar began to strengthen against the US dollar, car prices in Canada slowed down, converging with the trend in the United States.

This coincidence does not prove that this convergence is owing to the exchange rate. It could be due to the different markets for new automobiles in Canada and the United States, which tend to follow different trends.

The impact of different discounts offered in the two markets (in response to sales trends) further complicates the picture. In fact, prior to the turnaround of the Canadian dollar, car prices were rising in Canada and falling in the United States. However, this gradual drop of Canadian car prices to US rates of decline is consistent with what the effect of the exchange rate should be.

Computer prices in the two countries did not follow the same trend prior to the appreciation of the Canadian dollar. This raises the possibility that computers are peculiar in this regard, and that pricing to market may be taking place.

Prices of some goods rose in spite of a stronger dollar

Other goods that rely on the US dollar for a smaller part of their costs had little impact on the overall slowdown of the CPI.

The price increases among some actually accelerated. In fact, the prices of some goods in Canada, such as furniture and audio equipment, went in the opposite direction of what the impact of the exchange rate should be.

For example, household furniture relies on the US dollar for about 15% of its costs. Furniture prices in Canada as of January 2004 were 0.2% higher than they were a year earlier, while in the United States they declined 1.0%.

Audio equipment relies on the US dollar for about 22% of its costs. Prices fell in both countries, but the decline south of the border was faster: 5.6% in the United States compared with 3.4% in Canada.

Evidently, other factors besides the exchange rate have an impact on prices in the two countries.

Definitions, data sources and methods: survey number 2301.

The study The Soaring Loonie and Prices: Lower Inflation for Consumers? (11-621-MIE2004014, free) is now available online in the Analysis in brief series. From the Our products and services page, under Browse our Internet publications, choose Free, then Trade.

For more information, or to enquire about the concepts, methods or data quality of this release, contact Radu Chiru (613-951-3998), Prices Division.