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How the Bank of Canada is like a Doctor

Date posted: Feb. 15, 2018
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How the Bank of Canada is like a Doctor

How the Bank of Canada is like a Doctor

For borrowers, there’s an important message inside

You probably have never thought of the Bank of Canada as a doctor – but you should, because just like a doctor works to keep you in the best health, the Bank of Canada works to ensure the health of the country’s economy.

The Bank of Canada’s interest rate for major banks to borrow and lend money among themselves is one of those dry numbers you hear about on the news. The reasons behind the interest rate hikes, what they mean to you – or what Canada’s central bank is or even does – can be unclear. For the sake of your family’s finances, it’s helpful to have all the facts laid out in a clear way to understand the basics of what the Bank of Canada rate hike is all about and how it may affect your wallet’s health. Let’s break it down, step by step, to help you make informed decisions and keep your wallet’s health in tip-top shape financially.

What is the Bank of Canada/Banque du Canada?

Like a doctor would monitor the health of a patient, the Bank of Canada has four jobs to ensure the health of Canada’s economy:

  • Keep inflation low (i.e. keep the price of goods and services from rising over time so that you’re not spending more to buy groceries, for example).
  • Make sure the economy runs smoothly and efficiently
  • Produce currency (bank notes/cash money)
  • Manage cash used to pay debts in Canada or to foreign countries.

Doc, it hurts when I do this…

Just as a doctor might prescribe a bad-tasting medicine or tell a patient to exercise for their long-term benefit, so too does the bank when it makes decisions to maintain Canada’s economic health. In most cases, the bitter pill that needs to be swallowed comes after the Bank of Canada predicts the arrival of an illness that may affect the country. For example, we can think of inflation as a sickness because rising prices may cause Canadians to lower their standard of living, or take on more debt to keep up.

The prescription for inflation: How does the bank keep the cost of living from rising?

If the Bank of Canada thinks inflation may occur, it will sometimes increase the key policy interest rate, sometimes called the benchmark or overnight rate. This rate sets how much interest is paid by major banks and other financial institutions when they borrow and lend money with each other for one day. In January 2018, the Bank of Canada increased the interest rate by .25 per cent to 1.25. Because all the major banks keep a close watch on any adjustments made to the lending rate, on that very same day, Royal Bank, TD Canada Trust, CIBC, Bank of Montreal and Scotiabank all changed their lending rates to consumers to match up with the Bank of Canada. And that’s why the actions taken by the Bank of Canada have a direct effect on the finances of Canadians.

The side effects of the Bank of Canada’s interest rate hike: What does this mean?

Like any medication, the prescribed rate increase will have its own set of unpleasant side effects.

For anyone with mortgages, a line of credit, credit cards, student loans or other types of loans with an interest rate that is not fixed (i.e. the” variable rate” can change over time), you may find yourself paying more interest if the money lender raised their interest rate. This means it will take longer to pay off your debt and higher debt payments could cut into your living expenses.

If you’re like many Canadians who are living with debt, the best advice is to attack the debt more aggressively (as opposed to just paying the monthly minimum), and in so doing head off additional debt if there are more rate hikes.

Find more information on making smart personal finance decisions click here to download 10 ways to improve your credit and make smart money decisions.

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