Interest Rates in Canada Explained

January 26, 2023

How interest rates in Canada affect you

You can think of interest as the “Rent” paid to a lender of money. And the ability to borrow money is critical because there isn’t enough actual cash in the world.  So, interest rates or “rent” on borrowed money is a way of rewarding those who have lent out their precious capital to those who need it. All sorts of large businesses, such as banks and other financial institutions, lend out money, as well as individuals and small organizations, and retailers.  

If you have ever invested in a debt instrument such as a bond, GIC or Certificate of Deposit, then you have lent out money to an institution, and have collected interest.

Who sets interest rates in Canada?

Interest rates are determined mainly by a combination of the Central Banks around the world and the marketplace for borrowed money. In Canada, we have the Bank of Canada, and the U.S. has the U.S. Federal Reserve. These two institutions use their influence and legal power to direct short-term, overnight interest rates. This determines how much it will cost for all the central banks and financial institutions in each jurisdiction to borrow money from one another.

But the Central Banks only determine the interest rate over a very short time frame – literally the overnight cost! So the Central Banks do not directly dictate the interest rate on borrowing money over 30 days, for instance, or for 3 years, or what a mortgage rate should be. They do not direct or mandate the price or cost of borrowing money – except that overnight rate. But the Central Banks can exert some influence and what’s called “moral suasion” on the longer-term interest rate market by making statements on where they may intend to move the short-term overnight rate in the future.

But once that overnight rate is determined by the Bank of Canada, it is simply the marketplace which governs what interest rates are for most consumers – on our personal bank loans, mortgages, credit cards or the interest we can get on a GIC or a bond purchased on the bond market. All of that is determined by the marketplace.

How do interest rates affect you?

Interest rates in Canada have a huge impact on all parts of your life. They dictate the cost of financing everything. In particular, dramatically increased interest rates in Canada, as we are experiencing now, negatively impact many things, even if you do not have any debt.

Of course, if you have personal debt such as a car loan or a line of credit, then the cost of servicing that debt has risen significantly. If you have a variable-rate mortgage, then that monthly payment has gone up dramatically. If you have a fixed-rate mortgage coming up for renewal, you will shortly be under increasing pressure from a much higher mortgage rate. But because borrowing costs more – in many cases, rents have increased specifically because building owners themselves have to service ever higher interest rates on their mortgage. 

And much higher mortgage rates have also virtually halted the real estate market, and house prices have dropped significantly because people cannot afford the higher mortgage rates.  In general, interest rates impact all parts of our lives, even if we do not owe money.

What are Central Banks?

Central Banks are part of the Federal Government but not directed, controlled, or a part of a sitting elected government. Central Banks have two primary direct mandates, which are virtually identical on both sides of the border and are stated in order of importance.

Number 1) To keep inflation at about 2%

Number 2) To keep unemployment low

This is their only job. And they both have a lot of tools at their disposal to achieve this. The most impactful is that they control the money in our economy – or money supply – through monetary policy. Simply put, these people are actually in control of the printing press. In recent years, Central Banks have miserably failed, with inflation running at or above 40-year highs.

Pictured Above: The Central Bank of Canada

What is Modern Monetary Theory?

Many people ask us what Modern Monetary Theory is, sometimes known as MMT. Modern Monetary Theory has absolutely nothing to do with Modern Portfolio Theory or Construction, which refers to the scientific and mathematical process used by us at McIver Capital Management to allocate a portfolio to ensure the greatest mathematical probability of success.

Instead, Modern Monetary Theory is an extremely flawed academic theory that has lurked and festered for many years in universities. At its core, it is a theory – or a belief set – about how a Central Bank can use its control over Monetary Policy and the Supply of Money to control the population. MMT argues that spending and money printing by large, developed countries should be unrestricted by the resulting national debt they create.

• That a large national debt is not as crippling as we have been led to believe.
• And that if the government just prints more money and spends it on large national social programs, people will have more money and better free programs.

The risk and actual effect of applying Modern Monetary Theory is that all of us end up becoming indentured slaves to the State because the State runs everything. The State has to service the interest on a massive national debt. The only way to get that money is directly from its citizens through taxes and appropriations.

Or alternatively, the State can go further into debt to pay for the social programs. If that sounds familiar, that’s because it is. Far from being modern, such reckless policies and ideologies have been tried in the Soviet Union and, more recently in Venezuela and countless other failed states. If there’s ever been a time in recent history in which Modern Monetary theory has been proven to be a dangerous failure – it is now.

Interest Rates in Canada: Summarized

Interest rates in Canada play a crucial role in the economy and can greatly affect our daily lives. These rates affect everything – from the cost of borrowing money, to rents, housing prices, and the amount you can make on your savings. 

The Bank of Canada, along with the marketplace for borrowed money, determines the interest rates in Canada. While the Central Bank has the power to influence short-term, overnight interest rates, it is ultimately the marketplace that governs the rates for most consumers. With the current high interest rates in Canada, it is important to stay informed and aware of how they may affect your financial situation. “Interest Rates Canada” is a topic that affects all individuals and businesses, and it’s important to stay informed about the latest developments in this field.

Are you concerned about the possibility of a recession in 2023? Read our latest blog on the topic here.