The Bank of Canada and major lenders in Canada are raising interest rates in response to the Canadian economy’s spectacular performance in the second quarter of fiscal year 2017. The lesson plan examines the relationship between the state of an economy and interest rates.
Appropriate Subject Area(s):
Key Questions to Explore:
- What is the relationship between the state of an economy and interest rates?
- What impact could rising interest rates have on Canadian borrowers?
- What impact could a rise in interest rates have on Canadian lenders/savers?
- What factors does the Bank of Canada consider prior to raising interest rates?
- What is the relationship between interest rates and the exchange rate of the Canadian dollar?
Delinquency rate, household debt
- Delinquency rate is the percentage of loans on which debtors fail to make payments as they come due. The delinquency rate is simply the number of loans that have delinquent payments divided by the total number of loans an institution holds.
- Household debt is the combined debt of all people in a household. This includes mortgage debt on all residences and real estate, and consumer debt (including debt outstanding on credit cards, personal and home equity lines of credit, secured and unsecured loans from banks and other institutions, and unpaid bills).
- According to statistics Canada, the current debt to disposable income ratio is 167.8 per cent, up from 166.6 per cent in the first quarter.
A copy of the article
Introduction to lesson and task:
All things being equal, as a given economy grows the central bank is more likely to raise interest rates to reduce the risk of inflation. Equally, if there is a decline in economic growth, a central bank is more likely to reduce interest rates to prevent a recession.
Given the higher than expected growth in GDP (4.5% v. 2.5%) in the second quarter of 2017, the Bank of Canada decided to raise the benchmark interest rate from 0.75% to 1.00%. There is compelling evidence that growth in Canada is becoming more broadly-based and self-sustaining, given the stronger business investment and increasing exports in the last quarter. However, inflation is currently rising at less than the bank’s 2% target, and wages are not rising on a par with other developed nations.
Rising interest rates will negatively impact homeowners who have taken on record debt levels to buy homes, and other lenders who have borrowed to finance their spending. Due to higher interest rates, there might be increases in delinquency rates.
Generally, higher interest rates tend to increase the value of a given nation’s currency. However, the Bank of Canada believes that the Canadian dollar’s recent strength is due to the US dollar’s weakness and relative strength in the Canadian economy – not a rise in interest rates.
The Bank of Canada will make future rate decisions based on the economic data available and the economy’s sensitivity to higher rates, given elevated household debt.
Action (lesson plan and task):
- Ask your students to explain the relationship between GDP growth and interest rates.
- Ask your students to explain how a rise in the value of the Canadian dollar affects the competitiveness of Canadian exports on the foreign market.
- Ask your students to state how this increase in interest rates will benefit banks and other lenders.
- Ask your students to explain why an increase in business investments and exports indicates that GDP growth will be self-sustaining.
- Ask your students to state some of the negative impacts an increase in interest rates could have on the following groups:
- Homeowners who have taken on a mortgage
- Small business owners with a business loan
- Individuals who financed the purchase of consumer goods with a loan or line of credit
- Ask your student to anticipate how an increase in interest rates could impact the real estate markets in places like Toronto and Vancouver, where there is a high demand for houses.
- Ask your student to state the impacts an increase in delinquency rates could have on the Canadian economy.
- Ask your students to state some of the factors that could lead the Bank of Canada to raise interest rates.
Consolidation of Learning:
- Ask your students to research the key economic metrics the Bank of Canada analyzes prior to deciding whether to raise the benchmark interest rate
- After completing this lesson plan, students should have a better understanding of the relationship between economic growth and the benchmark interest rate.
- Ask your students to state how a rise in interest rate will impact borrowers.