Will raising interest rate help to control inflation?
Markham, Ontario, March 11, 2022
While the Central Banks around the world are looking at raising interest rates in hopes to control inflation, I am sorry to say I cannot see how this "traditional" way will work this time. In my opinion, raising interest rates will only lead to more Canadians going bankrupt, but the inflation will not be controlled.
Increasing the Interest rate can make people suffer
The reason? Let’s first see why we are having this surge of inflation…
Inflation in the last couple of years had gone outrageous, particularly, we experienced (and still officially hasn’t ended) the pandemic. Many fundamentals had changed because of that, and we have seen lots of issues in the global world followed by it.
Look at the following list (if you can think of more, please email me) of reasons why we have this round of inflation:
The global dependency of a handful of countries on supply chain
Many countries had sporadically shut down portions of their economy
The decrease on production on a wide range of products due to closure of businesses
Shortage of workers (might due to safety concerns) also led to production decrease
Production costs are also rising at a much faster rate than consumer prices. On top of that, we have:
Lesser in-person purchases (due to closures of businesses on lockdown) led to massive dependency of worldwide shipping, led to lack of storage and containers
Bottlenecks at many major ports where products are stuck
Fewer flights also created more constraints on international logistics
This is why inflation is surging.
In a normal world, as the central banks continue to withdraw their monetary stimulus and set their sights on raising interest rates, the economy will weaken. Too much tightening, historically, has been a catalyst for recessions. However, this is NOT a normal world.
The Canadian Government's Debt
Let’s put our government debt in Canada (which averaged $334.18 billion from 1962 until 2021, reaching an all-time high of $1048.75 billion in 2021) aside. Increasing credit activity
among Canadians with mortgage growth has pushed the overall consumer debt up to $2.2 trillion, an increase of 7.8% in Q3 2021. On an individual basis, the average consumer debt (excluding mortgages) is $20,739, a drop of 1.7% when compared to Q3 2020 because many had refinancing their homes since house prices had also gone outrageous, together with the low-interest rate environment.
Look at total Canadian mortgage debt, it ballooned by $118 billion to $1.7 trillion in 2020. The biggest increase since 2010. Household debt to disposable income reached 177.15% in Q3 2021 (which was 170.7% in Q4 2020). In 1980, that ratio was 66%.
In contrast, total debt payments in Q2 2020 was $192 billion, compared to Q4 2019’s $210 billion. Due to the fact that major banks in Canada had offered COVID relief – suspended mortgage payments, loan, and credit card deferrals. These deferrals mean that you don’t pay now but interest costs and higher payments come later.
The Employment Market is not great, too.
While many people had lost their jobs or had not enough working hours, many had taken on more debts. It becomes hard for Canadians to pay their mortgage debt (which accounts for an increasingly higher percentage of their total debt) because incomes don’t continue to rise - probably had dropped, the debt to income ratio will go up for sure.
With that said, the Bank of Canada is most certainly going to raise interest rates by a total of 75 basis points in the next few months, let’s see how bad our bankruptcy rate is going to get. So, how can we stop inflation getting higher? As I had mentioned on various occasions, we need to improve the local supply chain, strengthen local businesses, increase employment opportunities, then, we can improve individuals' income levels.
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