The Effects Of Rising Interest Rates

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Image source: thebalance.com

BY: FAZAAD BACCHUS

You may have seen recently that the Feds have made a decision to increase interest rates.

That happened in the United States and while we are a different economy from theirs, we are still tied somewhat to the hip. In our own economy, we have seen an increase in borrowing, a decrease in unemployment, an increase in overspending and this is a prime setting for a spike in inflation.

Fortunately, inflation has been holding steadily at 1.7% and should it start to rise we need to watch out for a possible interest rate increase. Why is that so? Well, inflation is usually an indication of over spending and what the Government tends to do is retract spending by raising interest rates. When rates go up, people spend less, therefore, reducing consumption and production alike. While this doesn’t sound like a good thing to do, it is sometimes quite necessary to keep the delicate balance of producing not too much or not too little and for keeping prices in check. As an example, if there was full employment in the world, wages would be so high that producers would have to raise their prices to make a profit. These prices, in turn, will be passed on to you the consumer, as you can see, the problem worsens.

The most significant impact affecting Canadians will be the cost of borrowing and debt repayment. Any loan will ultimately become more expensive and will require a larger output of money from you. However, the largest Canadian debt in consumer borrowing lies in their properties and not only in their investment properties but in their residential homes as well. A rise in interest rates of only 1% would send some scrambling as their budget is so tight. A typical detached home now is anywhere from 750,000 to 1,200,000 and with interest rates of about 1% more would cost you another $500.00 per month. This will prove to be catastrophic for many families especially if the rise in rates creates a glut of properties on the market and values start to fall. You would be holding a deed where the loan has more value that the property.

In the 1980’s interest rates were at an all-time high rising as much as 21% on home purchases, consider how that would affect you if rates were to go up again like that. Raising interest rates is not entirely bad as it can be the major factor in cooling inflation, home sales and over consumption, however, when left to run out of control can have quite damaging effects. Business and consumer confidence falls, less risk is taken and overall production starts to drag to a halt. Unemployment starts to rise and if a government is not careful is can find itself in a case of stagflation which means that the economy is not growing but inflation continues to rise. Here the government needs to put a fiscal stimulus to generate production, but this stimulus may be borrowed money as the Treasury may be bare or empty. It further weakens the economy.

As Canadians, we need to watch our spending carefully making sure that we are not spreading ourselves too thin, buying everything we own hinged on credit. If we will buy on credit, we should make sure that return on the investment is greater than the cost of it. Be careful of loans that do not show equity or value, as it would difficult to pay back something for which there is nothing to show.

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