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Inflation explained
Simply put, inflation is a way to show how prices change over time. Inflation relates to the “purchasing power” of money – meaning the same amount of money will buy fewer goods and services over time.
Inflation is represented by the percentage change in the consumer price index (CPI), which measures the cost of a basket of 600 goods and services, including housing, transportation, furniture, clothing and recreation. The Bank of Canada has a current target to keep inflation between 1 to 3 per cent annually.
While inflation is generally associated with rising prices, deflation is experienced when prices are falling.
Inflation calculator
Use this calculator from the Bank of Canada to see how prices have changed in the last 100 years.
Inflation risk
Inflation risk is the risk that your purchasing power will be reduced if the value of your investments does not keep up with inflation. Inflation risk is particularly relevant if you own cash or debt investments like bonds. Shares offer some protection against inflation because most companies can increase the prices that they charge to their customers.
Learn about other types of investment risk.
The effect of inflation on your investments
Inflation means higher consumer prices. This often slows sales and reduces profits. Higher prices will also often lead to higher interest rates. For example, the Bank of Canada may raise interest rates to slow down inflation. These changes tend to bring down stock prices. Commodities however, may do better with inflation, so their prices may rise.
The effect of deflation on your investments
Falling prices often mean lower profits for companies and decreased economic activity. Stock prices may go down, and investors may start selling their shares and moving to fixed-income investments like bonds. Interest rates may be lowered to encourage people to borrow more. The goal is to spur increased spending and economic activity. The Great Depression (1929-1939) was one of the worst periods of deflation ever.
How inflation affects your investment returns
Nominal rate of return
The amount of money you make on an investment before expenses – this rate of return does not take inflation into account.
Real rate of return
Your real rate of return is the nominal return on your investment minus the inflation rate, and gives you a better sense of the purchasing power of the money you make from your investments.
Key point
Inflation erodes the purchasing power of money over time – the same amount of money will buy fewer goods and services.
Take action
Use this calculator from the Bank of Canada to see how prices have changed in the last 100 years.
