Explain how does Bank of Canada’s decision affect Financial Institutions in Canada. Explain how does Bank of Canada’s decision affect Financial Institutions in Canada?

Question

"Bank of Canada has increased the interest rates twice in 2022, there are more rate hikes expected in 2022.” Explain how does Bank of Canada’s decision affect Financial Institutions in Canada. Explain how does Bank of Canada’s decision affect Financial Institutions in Canada?

Answer 1

What do policy interest rate hike do to the economy?

           Monetary policy has existed in several forms. In practice, however, it comes down to modifying the amount of money in circulation to accomplish some mix of inflation control and production stability. The vast majority of economists agree that, in the long term, production, which is often measured by gross domestic product (GDP), is constant, hence any changes in the money supply only affect prices. In the near term, however, since prices and wages do not often adapt instantly, changes in money supply may impact the production of real goods and services. This is why monetary policy; generally administered by central banks such as Bank of Canada, is an effective policy instrument for attaining inflation and growth goals.

           When interest rates increase, the interest rates on loans increase. With increased interest rates, credit card and loan interest payments are more costly. Consequently, this inhibits borrowing and spending. People who currently have loans will have less discretionary money when their interest payments increase (Pulkol, 2019). Consequently, other sectors of consumption will decline. The cost of borrowing increases, which may deter customers from borrowing. People with current variable loans or credit card debt may have less discretionary money if interest rates rise. In either scenario, consumer spending declines, resulting in an economic slowdown.

           Higher interest rates have a positive effect on the value of a currency (because of the hot money flows, investors/savers are more probable to save in Canadian if Canadian rates are higher than other countries) A higher CAD reduces the competitiveness of Canadian exports, hence boosting imports and decreasing exports (Mertens, & Williams, 2019). This has the consequence of decreasing economic aggregate demand.

           Increasing interest rates Decrease confidence of investors in a country. The rate of interest influences consumer and corporate confidence. An increase in interest rates discourages investment by reducing the willingness of enterprises and consumers to undertake risky investments and purchases (Mertens, & Williams, 2019).