Brush up on your economics, answer your clients’ questions and clear confusion about interest rates, inflation and investments with this article from Advisor to Client.
Next year, the Bank of Canada and the Ministry of Finance could move the national inflation target. Why would they do that? We’ll examine what it all means.
Inflation is the increase in the price of goods and services due to demand and the cost of production. Some is normal in a healthy economy as it encourages employers to raise wages and minimizes the effect of debt. But if there’s too much, people lose faith in their ability to buy things. Too little, and wages stagnate. Worse, deflation encourages people to put off spending, stifling economic growth.
Canada’s inflation target is where it’s been since 1995: 2%, though the Bank says between 1% and 3% is acceptable. The target is due for its regular five-year review in 2016. Generally, economists say countries that set targets tend to have more stable inflation.
By setting a target, the Bank is giving other market participants a guide by which to set prices for everything — whether it’s lawnmowers or bonds or salaries.
The target’s effectiveness comes from its credibility. Everyone has to believe the inflation target in order for it to work. That’s why it’s a big deal when the Bank thinks about changing it — which is exactly what it might do in 2016.
Canada’s total consumer price index (one of the measures of inflation) is presently 0.8%. It’s ranged from -0.9% to 3.4% since the 2008 financial crisis. Despite how low it is, some have suggested the Bank should raise the target. If the Bank does, the economy gets more breathing room in case there’s another crisis, allowing the Bank to combat unemployment and low economic growth.
To follow that logic, let’s examine how inflation and interest rates work.
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