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

Canada’s central bank wants you to know that rising interest rates are worthless, but in the end 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 impact on goods, but assumed that the reader would have some basic knowledge of how tariffs work. Since some people may not have that basic 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 that they believe is low enough not to overly erode money, but high enough to avoid “hoarding.” It’s a balance between not seeing the value of your labor decrease, but also letting it erode at a rate that you continue to spend and invest. The current inflation target is 2%, with a tolerance of one point higher or lower.

The primary tool used to control inflation is interest rates

The main tool they use to perform this task is interest rates. In Canada, overnight interest rates are particularly important as they affect the cost of most short-term loans. If inflation is too low, they lower interest rates to make debt cheap and encourage borrowing. When you borrow, you usually buy something. After all, how can you not spend on that house when the cost of borrowing is so low? You may have been planning to buy something later, but the cheap debt means now is the ideal time.

By stimulating demand, the central bank increases competition for goods and the price of those goods. To put it bluntly, the goal is to boost demand over supply to create a shortage of goods and drive up inflation. This whole concept works because credit can be made faster than supply chains can respond to the surge in demand.

Higher interest rates slow inflation and improve affordability

However, all good parties come to an end. Sometimes the stimulated supply, which is not natural, is exaggerated. In this situation, the opposite happens: interest rates rise and the cost of borrowing also rises. This reduces the incentive to borrow, reduces artificial demand and reduces competition for goods and services. Less demand reduces the pressure on supply, so prices stop rising. In some cases, prices may fall if the future expectation of price growth also financed supply.

Ultimately, the BoC makes the decision to control inflation over borrowing costs, as it is healthier for the economy. The National Bank of Canada (BoC) estimates that if the key rate rises to 3.25%, the impact would be about 1% of lost disposable income. Current inflation, on the other hand, means that 8 points are lost per year.

The BoC claims it will control inflation, which is a huge change from earlier this year when they claimed it was beyond their ability to control. It comes after the Canadian parliament called us to a committee to explain how the BoC created inflation, but hey – better late than never?

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