In a recent speech, Bank of Canada Governor Stephen Poloz suggested that a move to raise interest rates will likely be delayed again due to strong headwinds facing the Canadian economy.
Appropriate Subject Areas:
Key Questions to Explore:
- What is the difference between nominal interest rate and real interest rate?
- How do low interest rates affect individuals within a given economy?
- How do low interest rates affect the economy as a whole?
- What factors determine interest rates?
- What policies can be put in place to stimulate economic growth?
Nominal interest rate, real interest rate, inflation, monetary policy, overnight rate.
- Nominal interest rate refers to the interest rate before taking inflation into account. It can be calculated by adding inflation to the real interest rate – i.e. real interest rate + inflation = nominal interest rate.
- Real interest rate refers to an interest rate that has been adjusted to remove the effects of inflation. It can be calculated by subtracting inflation from the nominal interest rate – i.e. nominal interest rate – inflation = real interest rate.
- Inflation is a rise in the average price level of goods and services in the economy.
- Monetary policy is the process by which the Bank of Canada controls the supply of money, often targeting an inflation rate or interest rate to ensure price stability and general trust in the currency. The objective of Bank of Canada’s monetary policy is to preserve the value of money by keeping inflation low, stable and predictable.
- Overnight rate: This is the rate at which major financial institutions borrow from and lend to one another
- A copy of the article
- A copy of Stephen Poloz’s remarks.
- This is a link to the transcript of the speech: http://www.bankofcanada.ca/wp-content/uploads/2016/09/remarks-200916.pdf
Introduction to lesson and task:
The 2008 financial crisis had a profound impact on the global economy. In some ways, the Canadian economy has yet to fully recover.
Mr. Poloz made it clear in his prepared remarks that the bank of Canada is likely to delay an increase in interest rates due strong headwinds the Canadian economy is currently facing.
The Bank of Canada has set overnight lending rate at 0.5% since July 2015. The goal of this stimulative monetary policy was to encourage investment and bring the economy to perform at full capacity. However, the full effect of these fiscal stimulus has yet to take full effect. As a result, the Bank of Canada has decided to leave the overnight lending rate at 0.5%.
To get the economy back to performing at full capacity, Mr. Poloz proposes the following policy prescriptions: Identifying and removing the impediments to business growth; increased infrastructure spending; and trade liberalization.
Mr. Poloz believes that freer trade and more infrastructure spending could boost Canadian gross domestic product by 3 – 5%.
Action (lesson plan and task):
- Let students know that interest rates affect both borrowers and savers. When interest rates are low, savers and pensioners receive lower returns on their principal, which makes them unhappy. However, when interest rates are high, borrowers pay more in interest expense, which also makes them unhappy.
- Ask students if they can determine who is happy when the following changes occur to interest rates:
|Rise||Individuals with mortgages|
|Rise||Individual with student loans|
|Rise||Individuals with savings|
|Rise||Individuals with pensions|
|Drop||Individuals with mortgages|
|Drop||Individuals with student loans|
|Drop||Individuals with savings|
|Drop||Individuals with pensions|
- Let students know that interest rates are a lagging indicator – i.e. interest rates only change in response to large economic shifts like increases in housing starts, increase in new business startups, the performance of the stock markets and retail sales, etc.
- Ask students if they can identify some policy initiatives which will spur economic growth and lead to higher interest rates.
- Ask students what the effect of higher interest rates would be on the individuals within the economy.
Consolidation of learning:
Ask students to read about the proposed Trans-Pacific Partnership and determine how it could lead to an increase in GDP.
- After completing this schedule, students should be able to differentiate between nominal and real interest rate.
- They should be able to describe the relationship between nominal interest rate and inflation.
- They should be able to describe the factors that affect nominal interest rates
- Ask students to explain why the Bank of Canada has signalled a delay in its decision to raise interest rates.