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Thursday, December 7, 2023


The Bankers Dilemma: The Decision to Raise or not Raise Interest Rates

Editorial Cartoon by Graeme MacKay, The Hamilton Spectator

The paramount responsibility of the Bank of Canada’s (Boc) is to promote the economic and financial well-being of Canadians. Ensuring inflation at a target of 2 per cent, the midpoint of a 1 per cent to 3 per cent inflation control range, is deemed crucial in achieving the necessary price stability to generate predictable and sustainable economic growth

According to the monetary credo of the Bank, raising interest rates, making borrowing more expensive, will dampen the spending of both consumers and businesses. The decline in demand will slow economic growth and thus inflation. But there is a problem. As consumption and business activities go down unemployment rises. By reducing demand, interest rate hikes put people out of work.

It gets worse. Cooling demand for their goods and services encourages businesses to both reduce their supply and raise their prices, making them more expensive. This is likely to worsen inflation and often generates an affordability crisis for consumers.

Steep price increases in food, fuel, and particularly housing, coupled with the crippling interest rates by the BoC are the main driving forces behind the continuing inflationary pressures. Many Canadians have been pushed into a cost- of-living crisis.

A majority, 81%, worry that they have to pay more than they can afford for everyday essentials. And 55 per cent fear that they will not have enough money to feed their family.

Others are able to cope with their increased debt load as long as their job and income is steady. What they cannot afford is becoming un- or underemployed and facing ever-increasing interest costs on their debts, particularly their mortgages.

While spiking prices and higher borrowing costs affect people of all circumstances, the impacts are not shared equally. Credit holders and borrowers stand in an inverse relationship to one another. Their disparate circumstances can be compared to the imbalance between heavier and lighter riders on the opposing sides of a seesaw. Herein lies the policy dilemma for the Bank, one which it seems to ignore but that deserves a closer look.

The Bitter Pill for the Economically Vulnerable

High interest rates clearly hurt the economically vulnerable. They are generally younger, have less resources, face precarious employment prospects and struggle to make ends meet.

  • Recipients– such as low-paid, non-unionized wage earners, pensioners, and social benefit recipients
  • Borrowers– to buy a car, a house, to service or pay off outstanding debts
  • Homebuyers – in shrinking real estate markets home prices may rise and mortgage rates increase
  • Renters – Competition for available housing allows landlords to rent to the highest bidder
  • Social agencies– particularly foodbanks, struggling to meet the increasing demands and needs of users
  • Immigrants – not yet having found a material base in their new home
  • The Unemployed losing their breadwinner status and/or financial security
  • Governments higherinterest rates slow the economy and increase unemployment; the resultingloss of tax revenue and the resulting loss of tax revenue makes it more difficult to support the growing number of jobless

A Sweet Deal for the Beneficiaries

Those who will end up with more money in their pockets are the economically advantaged.

  • Borrowers with Existing-Fixed -Rate Loans – when money loses in value, they will pay lower real interest on their loans
  • Savers and long-term bondholders –the value of their money is protected
  • Energy Investors – Gas, oil, electricity remain in constant demand, offering a safe profit market
  • Agriculturists and Grocers – their products are constant consumption demands, allowing them to hike prices as much as they like
  • Banks -through credit cards, variable mortgage rates and other type of credit providing more income
  • Landlords and landowners – physical assets like land and housing hold their and value provide lucrative investment earnings
  • Insurance Companies –raise premiums for insurance coverage and reinvest premiums in interest earning assets
  • Speculative Art Collectors – investing in art works which grow or maintain their commercial value

Managing Inflation in the Post Covid-Era

The key problem for the BoC in its approach to controlling inflation is its misguided belief that the best antidote to it is to trigger economic decline and generate higher unemployment. This way of economic thinking is hopelessly outdated and damaging.

Initially, BoC took a wait and see attitude, expecting that the inflationary pressures were short-lived. When this did not happen, it responded with eight aggressive hikes in 2022, followed so far by three further hikes in 2023. This pushed the prime interest rate up to 5.0 %, the highest level in 22 years.

Inflation fell from a peak of 8.1% in June 2022 to 3.4 per cent in May 2023. This substantial drop of nearly 60 per cent was not enough for the BoC. Despite recognizing that interest hikes have a time lag of 18-24 month to take full effect the Bank insisted that its monetary policy had not been restrictive enough to cool down the economy.

Despite high interest rates, Canada’s economy grew faster and more strongly than expected. It grew by an annualized rate of 3.1% in the first 4 months of this year. This was good news for the manufacturing and wholesale trade sector but raised alarms for the BoC.

The Bank attributed persistent inflationary pressures to three factors: 1) An overheated economy, 2) A tight job market, and 3) Wage increases. None of these claims bear close scrutiny.

1.0 Despite supply chain bottlenecks in key sectors, the Canadian economy showed remarkable resilience. There was a strong resurgence in demand for goods and services in some sectors of the economy, often outstripping supply. This encouraged businesses to raise prices, heightening inflationary pressures.

2.0 The second but most troubling problem for the Bank was the exceptionally low unemployment rate of 5.4 per cent in June this year, but the highest it has been since August 2022. Interest rates had pushed it up by a mere 0.4 per cent from its record low of 4.9 per cent in June of the previous year. While low unemployment is a good for workers and communities, the Bank found the situation unsustainable.

3.0 It worried that a continued robust labour market would trigger another round of inflation with labour seeking to recoup its lost purchasing power in the pandemic. When Statistics Canada reported an annual wage increase of 5.1 per cent for 2022 the Bank, trapped in its neoliberal monetary framework, saw no other option but to dramatically raise the interest rates. The Centre for Policy Alternatives commented accordingly that for the Bank: “too many people have jobs and too many people are getting raises.”

Another way of looking at the economic landscape would be to consider growth, low unemployment, and rising wages as the best of all worlds. Jim Stanford from the Centre for Future Work in Vancouver seems to think so. “For the first time in two years, wages passed prices: average hourly wages grew 5.4 per cent over the preceding year, just slightly more than prices (up 5.2 per cent). If the wage increase seems minuscule, it is still good news for wage earners.”

Is it not preferable to have people working and contributing? Why are wage gains a problem? They were not one for the members of the governing council of the BoC. They accepted their recent bonuses without qualms. Also, the Bank simply ignored examples of price gouging in some business sectors.

Why should the unemployed have to bear the brunt of punishing interest rates for the rest of us who remain employed? The Bank stubbornly insists that returning to a 2% inflation rate is the best way to achieve maximum sustainable employment (Tiff Macklem, at the Public Policy Form, Nov. 10, 2022). Several economists both within Canada and around the world do not agree, pointing to political solutions such as price controls or excess profit taxes.

In the US, the Fed was given a dual mandate to consider the impact on employment in setting interest rates. The BoC’s mandate from the federal government, renewed on December 13, 2021, is more ambiguous in this respect. At the press conference about the renewal, Governor Tiff Macklem acknowledged that the Bank would use its extended monetary policy tools when needed to actively seek “the maximum level of employment that is consistent with price stability when CONDITIONS WARRANT.” This can only mean that the unemployment rate will be as high as the Bank sees fit.

Recognizing that job losses come with human costs Macklen sought to mollify their impact, insisting that the large number of vacancies in the present tight labour market would prevent “the kind of large surge in unemployment that we have typically experienced in recessions”. This assurance can be little consolation for those who lost or will lose their jobs and income.

Macklem has not ruled out further rate increases since inflation was 3.3% in July up from 2.8% in June. If he does, it would be important to know how many jobs would be lost at what level of increase in the interest rate.

The question remains, however, whether further rate increases are really necessary.  The Canadian Chamber of Commerce reports (August 22,2023) that consumer spending is down 8.5% in Ontario and 3.6% nationally, indicating that the rate hikes are starting to kick in. One would hope that the BoC takes this as a clear signal to hold off on further rate hikes.

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