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Economy Lab

Higher gasoline prices are good for Canada. Really Add to ...

If there is a proposition in economics that can aspire to law-like status, it is surely Easterbrook’s Law: “All economic news is bad.” This is a truly powerful insight, and it explains how phenomena that would ordinarily be seen as good news are generally portrayed as a problem demanding government intervention. And so it is with the recent rise in gasoline prices.



Notwithstanding the fact that the pass-through from oil prices to the prices of refined fuels is not immediate or smooth, the proximate cause for the rise in gasoline prices is the recent run-up in oil prices. This increase is bad news for consumers, but good news for producers -- and Canada is an important net exporter of oil.



Higher prices for oil and other commodities don’t necessarily show up in the data for GDP: higher prices don’t necessarily mean more production. But they do play a major role in movements in GDI -- Gross Domestic Income -- which is a measure of Canadians’ buying power. See here for a more detailed explanation of the difference between GDP and GDI and of how they are related to commodity prices.



During the 2002-2008 expansion, about 40 per cent of the increase in Canadian GDI was due to the increase in our terms of trade, and they account for a significant fraction of the post-recession recovery in purchasing power.



So how can higher gasoline prices be consistent with increased purchasing power? The answer is that we are observing a relative price shift. The prices of some goods -- notably gasoline -- have increased. But the prices of other goods have fallen, most notably imported goods that have been made cheaper by an appreciating Canadian dollar. The overall net effect on Canadians’ buying power is positive.



To be sure, there are some people for whom this shift is genuinely bad news: many with low incomes may not be able to easily reduce their consumption of gasoline. But the real problem facing these households is that they have low incomes. As my Economy Lab colleague Kevin Milligan puts it, intervening to reduce gasoline prices is a price solution for an income problem (see also here). The proper remedy is to provide increased income support for those who need it.





Stephen Gordon is a professor of economics at Laval University in Quebec City and a fellow of the Centre interuniversitaire sur le risque, les politiques économiques et l'emploi (CIRPÉE). He also maintains the economics blog Worthwhile Canadian Initiative.



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