Federal spending played key role in pandemic-era inflation, new report finds

Canadians saw inflation hit 8.1% in June 2022, the highest rate in nearly 40 years. But while prices have cooled since, authors David Andolfatto and Fernando Martin suggest that fiscal policy played a larger role than previously acknowledged.

“The fiscal policy responses to pandemic-induced disruptions in economic activity were primarily responsible for the 2021-22 inflation surge, and there was little the Bank of Canada could have done to prevent it from happening,” the report finds.

The high cost of pandemic relief

According to the report, the federal government spent more than $360 billion between 2020 and 2022 on pandemic-related income support programs, like the Canada Emergency Response Benefit (CERB) and the Canada Emergency Wage Subsidy (CEWS). In 2020 alone, over 20 million Canadian adults — more than two-thirds of the adult population — received some form of direct financial support.

These transfers were crucial to buffering incomes during lockdowns and business closures. But Andolfatto and Martin argue they also left many households with more disposable income than they could spend, particularly as supply chains remained strained.

“This surge in nominal wealth, coupled with ongoing production bottlenecks, pushed inflation persistently higher,” the report says. The pandemic era saw demand increase for certain goods, in particular real estate, as well as furniture, electronics and vehicles.

Energy costs surged too. Gasoline prices shot up more than 50% between spring 2021 and mid‑2022, peaking with a 54.6% year-over-year jump in June 2022. That spike rippled through the economy, pushing up transportation and delivery costs, which in turn drove food and goods prices higher.

The Bank of Canada was late, but not to blame

The Bank of Canada (BoC) has publicly acknowledged that it was slow to raise interest rates, according to the report. But Andolfatto and Martin argue that monetary policy alone cannot account for the full scope of Canada’s inflationary episode.

From April 2020 through early 2022, the BoC maintained near-zero interest rates and purchased hundreds of billions of dollars in government bonds. But the authors note that the real driver of inflation was the increase in purchasing power created by the federal government’s direct payments, regardless of whether they were funded by new money or new debt.