The main determinant of underlying inflationary pressures is the output gap – the difference between actual output and potential output. When the demand for goods and services causes the economy to operate near capacity, there is upward pressure on prices. Conversely, a shortfall in demand tends to put downward pressure on prices.
However, a wide variety of factors can complicate the analysis of inflationary pressures, such as the transitory impact of exchange rate fluctuations or sector-specific price movements. In recent years, the behaviour of inflation in Canada and other advanced economies has been surprising, even when we take into account these temporary factors (Chart 1).