What Exactly is the Point of Hiking Interest Rates?

Since September of last year, the Bank of Canada has raised its key overnight lending rate seven times. Yet, the core inflation, the reason why any central bank modifies the country’s interest rates, has remained a steady two percent or less. In fact, for the past 37 quarters, 30 of them reported inflation below two percent. Regardless, the Bank of Canada found it prudent to change its lending rate more than 40 times. Why, exactly, remains a mystery!

Looking ahead to 2008, core inflation is expected to keep within the two percent mark, even with prices of oil averaged at US$75.00 per barrel. Notably, energy prices are excluded from core inflation calculations. However, if energy prices were to decrease substantially, Canada’s economy would effectively shift into just as unpleasant deflation mode.

Economists are now asking themselves what is a better guard of inflation-interest rates or the strength of a country’s currency. Statistics Canada reports that rising Canadian dollar has compelled the overall economy to become more productive, saving Canadians and their businesses billions of dollars in the process.

It is obvious to me that Canada’s markets have the ingenuity and ability to keep themselves in check, as well as inflation, and are doing a much better job than the central bank’s manipulation of interest rates. I guess part of the infatuation with interest rates can be blamed on Canada’s long surpassed idea that our economy should mirror whatever happens with the U.S. economy.

Well, since the late 1990s, this was hardly the case. The two countries went their separate ways economically when debts and fiscal deficits began to define us. For example, Canadians no longer have to control inflation with interest rates. Unlike the U.S., our currency is strong and doing the job just right.

I guess what I’m trying to say is that in spite of an occasional unpleasant pullback, Canada’s markets have proved themselves quite capable of disciplining the economy. Interest rates are supposed to slow down the overly keen economy. But, losing a few foreign sales because of the strong Canadian dollar can do the trick just the same, only without the melodrama and media hype. Granted, it is a less “sexy” approach to policing inflation, but just as effective.

Having 30 out of 37 quarters of inflation below two percent, regardless of what happened to interest rates, is enough of a reason to stop fretting about them. Surely, some aspects of our day-to- day lives are still going to be impacted by interest rates. However, we should devote more faith to other forces leading our economy in the right direction, such as our strong dollar, high productivity levels, expanding commodity markets, etc.