The Bank of Canada is moving ahead with yet another rate hike, despite decades of high inflation rates and record-low unemployment rates.
So, what do you need to know about the connection between interest rates and the labour market?
According to Apple News “The key policy rate, also known as the target for the overnight rate, is how much interest the Bank of Canada wants commercial banks to charge when lending each other money overnight to settle daily balances. Knowing how much it costs to lend money, or deposit it with the central bank, helps set the interest rates charged on things like loans and mortgages.
Lowering the key rate makes it cheaper to borrow and spend, usually during economic downturns when inflation rates are too low, with the goal of creating growth. Raising rates has the opposite effect by cooling spending when inflation rises above the Bank of Canada’s comfort zone of between one and three per cent”.
What is the status of the Canadian inflation rate at the moment?
According to Statistics Canada “In January 2022, Canadian inflation surpassed 5% for the first time since September 1991, rising 5.1% on a year-over-year basis and up from a 4.8% gain in December 2021. In comparison, the headline Consumer Price Index (CPI) increased 1.0% on a year-over-year basis in January 2021.
Excluding gasoline, the CPI rose 4.3% year over year in January 2022—the fastest pace since the introduction of the index in 1999. COVID-19 pandemic-related challenges continue to weigh on supply chains, and consumer energy prices remain elevated. Taken together, Canadians continued to feel the impact of rising prices for goods and services, especially for housing, food and gasoline.
On a monthly basis, the CPI rose 0.9% in January, the largest increase since January 2017, following a 0.1% decline in December 2021.
Why are inflation rates so high right now?
One of the main reasons is demand for goods like household items is outpacing the capacity of manufacturers and supply chains. That has driven up the cost for the limited supply of goods, but also shipping costs that show up in price increases.
But as Moshe Lander, Course Lecturer, Department of Economics noted recently:
“The current inflation that Canada is experiencing is transitory in nature and supply side-driven, due to the perfect confluence of COVID-19, natural disasters, supply-chain disruptions and rising global tensions. Most inflationary pressure usually originated in the demand side and the Bank of Canada is much more capable of managing this. Unfortunately, supply-side inflation is much harder for the Bank to control. If the current round of inflation does not spill over into increasing wage demands, then it will dissipate as soon as the various supply-side issues go away. If it does spill over into increasing wage demands, then the Bank will have to act aggressively, likely triggering a deep recession that could destabilize the housing and financial markets.”
How does this affect the labour market?
Inflation affects labor market efficiency by influencing firms’ wage-setting practices and compensation schemes. In economies with competitive labor, capital, and product markets, comparable workers at equivalent jobs will tend to be compensated similarly.
According to Investopedia “The relationship between inflation and unemployment has traditionally been an inverse correlation. However, this relationship is more complicated than it appears at first glance, and it has broken down on a number of occasions over the past 50 years.” Since inflation and employment (and unemployment) are some of the most closely monitored economic indicators, we’ll delve into their relationship and how they affect the overall economy.
As we can see, in order to understand how different events affect us all, we have to understand how the economy works. We need to think of the economy as a kind of ecosystem, a system that is full of various niches and levels.
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