“Strong Demand driving economic growth, could mean higher interest rates”- Canadian Press, April 27, Sandra Cordon
http://www.canada.com/ottawacitizen/news/story.html?id=ef61a5ed-f503-476c-b766-dbb654621374&k=4363&p=2
Summary
It was reported by the Bank of Canada that strong demand in Canadian resources and domestic good has caused gross domestic product to increase, and higher interest rates might be the solution to keep inflation down. It is expected that the GDP growth will be 3% (as compared to 2.9% in a previous prediction) for 2007 and 2.9% for 2008. The forecasted growth is even more in the United States which leads to higher demand for Canadian exports. The central bank is debating whether to increase interest rates at least one more time to off-set inflation. Balancing inflation is not an easy task especially when high energy prices can create volatility in inflation rate. Due to the strong Canadian dollar, high and volatile energy costs are off-set by reduced price of imported goods. Also, government’s plan to cut GST by 1% will help decrease inflation. Globally, the growth averages to 4.8% because of amazing growth in China and in other parts of Asia. Housing investment also increases, which is surprising; despite the increase in interest rate.
Relationship and Reflection
When inflation increases, one way to counter-balance it is to raise the interest rate. The decision on whether or not to invest often depends on the cost of borrowing. If borrowing costs (interest rates) are high, then investment spending will be reduced. Some equipment purchase that is regarded as marginally profitable will be abandoned. When interest rates are high, households are encouraged to save money because the return they get for leaving money in the bank or other financial institutions are also high.
Manipulating interest rates is a good strategy to off-set GDP increases and inflation since spending is sensitive to changes in interest rates. Furthermore, the decreases in investment and consumption have a multiplier effect on the GDP level. This multiplier effect also applies to changes in government tax. Therefore the 1% GST cut mentioned above will also have a rather significant impact on GDP.
posted by Tiffany King @ 11:37 PM
4 Comments:
Tiffy ^^
It’s interesting to see how the Bank of Canada actually tries to keep inflation in check and “healthy”. They have to look at so many things that can affect the rates and what is a suitable level. I wonder how they judge what levels to be appropriate for the moment, not to change it? I wonder how many times they get it wrong, or is there no way of knowing, since isn’t it all just speculation? I guess we have a lot more to learn until we’re able to do this ourselves =D This article is a good example that shows how demand could affect inflation, and what the monetary policy does to correct it.
- V.Duong
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wini_lao said...
Hey Tiffany! Guess what, we did the same article hahah! Anyways, it is interesting to see that our economy is a repeating cycle! The prices in Canada are rising quickly-just look at the gas prices! This may cause inflation to happen, however, not all inflations are bad. If prices increase from 2.0% to 2.5%, then this is a good inflation. However, if it exceeds this percentage, we will have to control it, perhaps by increasing interest rate. Like you've said, this will cause people to save more and spend less, which will be unhealthy to our economy. Also, it is quite surprising to see the house market to do so well with such high interest rates. I wonder what kept the market going.
-W. Lao
I have to agree with you on this. With higher interest rates, people would definitely save more and spend less. It happens all the time that there is a sudden rise in gas prices. It most likely would cause inflation but if it were in the range of 2 to 2.5 then it would not affect the economy. If it goes over that range, the economy would be affected. Surprisingly, the house markets still do well in higher interest rate. I think that is what keeps the economy going. It is kind of unexpected but that might the leading factor to keep the economy going.
C. Choi
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