Higher Rates Lower Your Cost of Living, “We Know It’s Difficult”: Bank of Canada

Canada’s central bank wants you to know rising rates suck, but ultimately it will make life more affordable. This week the Bank of Canada (BoC) posted a Twitter thread on why higher interest rates will make life more affordable. They explained the influence on goods but assumed the reader would have some base knowledge on how rates work. Since some people might not have that base knowledge, we thought we’d break down how higher rates will ultimately improve the cost of living. 

The Central Bank’s Primary Mandate Is To Control Inflation

The primary role of the central bank is to control inflation, which ultimately means the value of money. They try to do this by keeping it at a level they feel is low enough to not excessively erode money, but high enough to prevent “hoarding.” It’s a balance between not seeing the value of your labor erode, but also having it erode at a rate you’ll keep spending and investing. The current target rate of inflation is 2%, with a tolerance of one-point higher or lower. 

The Primary Tool Used To Control Inflation Is Interest Rates

The primary tool they use to execute this task are interest rates. In Canada, the overnight rate is a particularly important one, influencing the cost of most short-term credit. If inflation is too low, they slash rates to make debt cheap, incentivizing borrowing. Usually if you’re borrowing, you’re buying something. Afterall, how can you not splurge on that house when the cost of borrowing is this low? You might have been planning to buy something later, but the cheap debt means this is the ideal time. 

By stimulating demand, the central bank is increasing competition for goods, and the price of those goods. To put it bluntly, the goal is to stimulate demand in excess of supply to create a shortage of goods, boosting inflation. This whole concept works since credit can be made faster than supply chains can respond to the increase in demand. 

Higher Interest Rates Will Slow Inflation And Improve Affordability

All good parties come to an end though. Sometimes the stimulated demand, which is not natural, becomes excessive. In this situation the opposite happens — interest rates rise and the cost of borrowing does as well. This reduces incentive to borrow, reducing the artificial demand and lowering competition for goods and services. Less demand reduces the strain on supply, so prices stop rising. In some cases prices may fall if the future expectation of price growth was also funding supply. 

Ultimately the BoC is making the decision to control inflation over the cost of financing since it’s healthier for the economy. National Bank of Canada (BoC) estimates if the policy rate rises to 3.25%, the impact would be about 1% of disposable income lost. In contrast, the current rate of inflation means 8 points are being lost per year. 

The BoC asserts it will control inflation, which is a huge change from earlier this year when they claimed it was outside of their ability to control. It comes after Canadian Parliament summoned us to a committee to explain how the BoC was creating inflation, but hey — better late than never?

14 Comments

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  • Matt 2 months ago

    How about reduce printing.

  • Remington 2 months ago

    What they left out was that the fiat currency which isn’t backed by anything is collapsing. They’re losing all control and can no longer manipulate the economy like they have been doing for years. Raising rates isn’t going to help and things are going to get worse.

    • Gerald Silva 2 months ago

      Thank you. You hit the nail right on the head. Most people will not understand what you are saying.

  • Chris Hotte 2 months ago

    Backed currencies aren’t worth anything when a loss of confidence creates a run. We saw that. With fiat all you have to do is shout ‘abracadabra!’ and you can fix it. Fiat is infinitely more flexible with the interest rate lever. You just have to pull it and watch, pull again and watch in baby steps or it could go badly.

    I don’t know why people are so upset with the turtle structure of fiat currency. Its no different for morality or laws. Everything is smoke and mirrors when we fail to abide.

  • FlipG 2 months ago

    Actually the fiat currency is backed by the Government of Canada; which means fiat currency isn’t quite as bad as it sounds.

    I think gold and bittcoin are even more unhinged.

    • Frank 2 months ago

      So then it’s backed by nothing.

      • derp 2 months ago

        Backed by monopoly of force, gold and mineral reserves, petrodollar. We’re a resource rich country. If shit hits the fan, our currency will be strong. That’s why everyone wants to bring their wealth here, it’s legitimized and secured in the process.

    • It's different this time 2 months ago

      The point he was trying to make is that there is nothing physical such as gold backing the currency. Instead the currency is backed by the countries economic standing and performance. The economy is shit, the country is in massive debt, and they watered down the currency by printing massive amounts of it. Every economy that has ever collapsed has gone down the same path of money expansion and it has never ended well. Smart money is moving into physical assets such as land, gold, silver, etc…. Only a matter of time before things collapse. I know people like to compare this to the 1970’s stagflation but this is much worse as households had very little debt back then. The poor and middle class are going to be decimated.

    • W8 2 months ago

      Try paying for things with paper $CAD’s elsewhere in the world. Worth about the same as monopoly money – similar colour scheme too! Many places can’t even exchange $CAD for local currency owing to limited value.

      Further, owning $CAD now comes with risk that domestic government may freeze your bank account(s) lest you embarrass them with conscientious questioning or criticism.

      Gold and even hyper-volatile BTC are much safer options for storing and transferring value of one’s labour.

    • Average Man 2 months ago

      Disagree. Bitcoin, I admit, the real value is TBD. But gold is gold. Gold’s track record as a store of value and a currency is thousands of years old. Gold is the undisputed champion. But if you don’t believe that, that’s cool too. I’ll take yours off your hands for you for a fair price.

  • Jk 2 months ago

    My major cost of living is my mortgage… Higher rates may help reduce prices on descretionary items, but that’s not gonna help me when monthly mortgage payments are up 30%…

  • Dan 2 months ago

    explain what that means ” fiat is backed by govt of Canada” . they print money which gets circulated and exchanged into other currencies. no control over that. its not backed by gold like USD used to be pre 1960’s. i think you have no understanding on monetary policy or macroeconomics.

  • Dennis_K 2 months ago

    So, is the corollary to the BoC’s tweet saying: “Yes, we at the Bank of Canada lowered interest rates (further) during the pandemic, in order to induce more demand, during a global slowdown in supply (both in terms of amount being produced as well as rate of delivery), just so that we could increase the cost of living.” ???? Wow.

    Seems like the prudent approach should have been to ‘stabilize’ society, both in terms of each household’s ability to maintain livelihoods, and general public health. Not to stimulate excess demand while production couldn’t be maintained. Stimulating demand (and providing liquidity) in that kind of environment just seemed to put way more money into the hands of people who already controlled the means of production and distribution. I haven’t seen (yet) anything of social benefit that came from such ‘stimulation’ — you?

  • Dennis_K 2 months ago

    So, is the corollary to the BoC’s tweet saying: “Yes, we at the Bank of Canada lowered interest rates (further) during the pandemic, in order to induce more demand, during a global slowdown in supply (both in terms of amount being produced as well as rate of delivery), just so that we could increase the cost of living.” ???? Wow.

    Seems like the prudent approach should have been to ‘stabilize’ society, both in terms of each household’s ability to maintain livelihoods, and general public health. Not to stimulate excess demand while production couldn’t be maintained (i.e in a supply-constrained environment). Stimulating demand (and providing liquidity) in that kind of environment just seemed to put way more money into the hands of people who already controlled the means of production and distribution. I haven’t seen (yet) anything of social benefit that came from such ‘stimulation’ (e.g. clean energy production, more efficient waste handling / minimization, less intensive air pollution, healthier / more local food production, etc.) — you?

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