Friday, February 23, 2018

Calculated Thought: Matters of interest, part deux

November 2, 2016 by Sean Annable, contributing writer

Last issue I voiced an ominous warning to not celebrate low interest rates, as they can be a sign of wobbling economies grasping for growth. And at such extreme lows, rates generally have only one direction to go. If interest rates rise, it shows that there’s confidence in our economy, which hopefully means wage increases and job creation. The general sentiment is that rates in Canada won’t rise soon, but many say that it’s inevitable. When they do, debt will become more expensive to manage.

So what influences the prime rate tied to your student loans? Most impactful is the central bank’s overnight interest rate, or “key rate.” The Bank of Canada (BOC) is our central bank; it’s a mostly autonomous Crown corporation. They hold our federal government’s cash; they design and distribute our currency; they manage our financial system.

Calculated Thought is a column dealing with student finances that is featured in every issue of Nexus.

Calculated Thought is a column dealing with student finances that is featured in every issue of Nexus.

Their main objective is to keep inflation at a “low, stable, and predictable” level, according to their website; two percent is where they like it. The BOC targets inflation through monetary policy, foremost by guiding our economy with changes to the overnight interest rate, which is the rate banks use when they lend, short-term, amongst themselves. The BOC will raise the key rate to cool a hot market when prices rise too quickly and lower it when the economy is stumbling.

A change in this rate signals banks to follow suit; they aren’t forced to react, but to stay competitive, they normally adjust their prime rate in tandem.

Currently, our key rate sits at a historically low 0.5 percent. With these low rates in place, businesses are, ideally, investing in new projects that create jobs, and consumers will access cheap credit to finance purchases to keep consumption chugging along. It would seem the latter is happening more than the former, particularly with residential mortgage debt.

Greater numbers of mortgages accessible through cheaper credit increases demand for houses, causing prices to jump.

It’s not all bad—if interest rates and house prices have an inverse relationship, as the data would suggest, maybe rising rates over the next decade will mean (relatively) cheaper houses for us students by the time we’re ready to buy.

Hey, we can always dream.

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