EDMONTON, AB Jun 23, 2015/ Troy Media/ – We rely a lot of a change in the quarterly Gross Domestic Product, the Toronto Stock Exchange and the concentration of CO2 in our atmosphere to measure our state of optimism or despair.
But one number in particular is so important there is coverage if there is a mere chance it may move. For the past few months, I’ve been seeing speculation about the possibility that the Bank of Canada will adjust its target lending rate, the rate at which banks lend each other money on very short term or “overnight” contracts. That rate, at 0.75 per cent, in turn affects the interest rate that banks charge on all their other loans, to businesses and consumers. It’s a “floor” interest rate, below which banks do not tend to make loans.
The market watchers predict the Bank will follow its peer in the United States, the Federal Reserve, if the Fed raises its target rate later this year. In an economy so dependent on loaned money, this floor rate is hugely important.
It matters to the millions of Canadian households with variable-rate mortgages. Unlike other home buyers who opt for fixed-rate mortgages, variable rates, as the name suggests, vary over time. With interest rates at historic lows (thanks to the Bank of Canada and Federal Reserves’ fiscal policies of encouraging easy lending to produce growth) this has been great news for those homeowners, as they have paid lower interest on their loans than their peers. If the Bank pushes the rate upward, on the other hand, many of them face unsustainable mortgage payments.
Low interest rates fueling speculation
At the same time, low interest rates are driving money into property speculation, inflating the value of homes in many markets (like Vancouver and Toronto). Raising the rate could pop this fragile real estate asset bubble, with wide-ranging effects on the Canadian economy.
The Bank of Canada wants (eventually) to raise the rate to build protection against the next recession – cutting prime interest and encouraging businesses and households to consume is one way to manage those periodic shocks. At the same time, raising the rate could put a serious strain on many households. What ought the Bank to do?
It all comes down to a moral question: Do you have a responsibility to save people who made (what may turn out to be) bad decisions based on your actions? The Bank did not force Canadians to take out mortgages, but its low lending rates set off a wave of speculation and make very expensive homes seem affordable. One could argue that the Bank ought to keep its rates low for the foreseeable future to allow debt-heavy homeowners time to get their head fully above water.
However, there is no reason to think that they would take the hint, or that more people wouldn’t be tempted to buy homes they cannot afford at historic (much higher) rates of interest.
As the great French economist Frederic Bastiat reminded his readers, we must always seek to pay attention to both what is seen and what is not seen. Those homeowners in severe debt are what is visible. But the broader base of citizens whose jobs are endangered by an economic recession are invisible. Without a higher target rate, the Bank will have no tools with which to stabilize the economy during the next inevitable recession.
You are responsible for your own unwise decisions
Then, many more people will lose their jobs than would have done so, including many of those who are in such deep debt.
Target lending rates are a blunt tool with many effects and consequences. It may be hard to define responsibility exactly in many situations, but here is one where the Bank cannot be blamed. It is surely not the Bank of Canada’s intention that people should make risky and potentially unwise financial decisions, but it is an unavoidable consequence to protect the larger economy. It is time to start gradually raising that fundamental interest rate.
Michael Flood is a marketing writer and communications consultant. He holds an MA in Philosophy from the University of Alberta.