Strong demand driving economic growth, could mean higher interest rates Sandra Cordon, Canadian Press, Published: Thursday, April 27, 2006 http://www.canada.com/ottawacitizen/news/story.html?id=ef61a5ed-f503-476c-b766-dbb654621374&k=4363&p=1
Summary
In the latest monetary policy report, the central bank forecast that Canada's GDP will expand by 3.1 % this year and has increased its forecast to 3% from 2.9% in 2001. However, the pace will slow down slightly to 2.9% in 2008. While prices are increasing moderately, higher interest rates may need to keep the lid on inflation. Also, increase in the policy interest rate may be necessary to keep aggregate supply and demand in balance and prevent inflation. Canada is growing strongly due to the booming energy economy in western Canada. Also, US economy is expanding in the mean time, which would increase demand for Canadian exports. Analysts have stated that Bank of Canada may increase borrowing costs. Prospects for higher Canadian interest rates pushed up the Canadian dollar by 0.43 of a cent to 89.04 cents US. The central bank adjusts interest rates to keep inflation under control in a growing economy. That rate in March was 2.2%, but analysts have warned that oil prices are bound to increase the total cost of living in April and beyond. However, central bankers don't expect that the high costs will cause inflations. Government's plan of cutting federal goods-services tax by one % have helped hold down overall inflation. Still, the strong loonie have held back the export sector, leaving domestic demand to keep the economy floating. Housing investment will likely rise a bit but slow down next year.
Relationship and Reflection
When prices increase, it is likely that inflation will occur so it is necessary to increase taxes to prevent it. However, not all inflation is bad; there are good inflations as well. If the prices increase from 2.0 to 2.5%, then this is considered good inflation as it helps expand our economy. If prices exceeded this percentage, then this inflation is considered bad. According to the monetary policy, when interest rates increase, household savings will increase as well because deposits in the bank can help people earn more money. This will lead to a decrease in spending, production as well as GDP and less income available to households. Also, business investments will decrease because the costs of borrowing to invest are high and the investments tend to be low. A decrease in investments will cause a decrease in spending as well as GDP. Overall, money will go out of circulation and spending will decrease, slowing down the economy. When there is less spending in the economy, aggregate demand decreases and so will prices. This will help keep aggregate demand and aggregate supply balanced, which can help establish equilibrium GDP. The level of GDP will always move towards equilibrium. When the amount of savings is greater than investment, investments will naturally go down to bring it towards equilibrium. I think it is quite surprising that the housing market is doing so well despite the high interest rates. Usually, with such high interest rates, people will not borrow money from the bank to mortgage. However, with the economy doing so well at this stage, investing in houses can help people make a lot of income. This will in turn increase our income and bring up our GDP. Also, as income increases, people tend to spend more in the market, which drives up prices. High prices can lead to inflation, and high interest rate is needed to control it. This cycle keeps repeating, keeping GDP at its equilibrium.
posted by wini_lao @ 3:09 AM
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