A senior economist expresses doubt that raising rates is the way to go when it comes to addressing inflation
Amid the sharp growth in the inflation rate over the past few months, the Bank of Canada has committed to raising its rates earlier than expected – although these hikes might not prove to be the balm that experts are anticipating them to be, according to Hendrix Vachon, senior economist at Desjardins.
“It is important to remember that raising interest rates is not a miracle cure, especially in the current context,” said Vachon. “There are several arguments for moderate monetary firming in 2022. For now, our main scenario calls for three 25‑basis‑point key interest rate increases in the United States and Canada.”
This is largely because inflation is mostly influenced by consumer-side factors, leaving central banks ill-equipped to counteract inflation triggered by supply-and-demand issues.
“Currently, in many countries, the production of goods and services is still being constrained by the impacts of the pandemic and public health measures. Raising interest rates in this context would not help resolve the supply problems,” Vachon said. “The best remedy would be favourable pandemic developments, with public health measures being lifted.”
Read more: What would a massive US rate hike mean for Canada?
Moreover, rate hikes might end up being a cure worse than the disease, Vachon warned.
“Raising [rates] would essentially result in curbing consumption and investment. This could still help lower inflation, but at the cost of an economic slowdown,” Vachon said. “In the worst case scenarios, the combined impact of still weak supply and demand that is being curbed by several interest rate increases could precipitate another recession in early 2023.”
The housing market is at particular risk of such fluctuations, the analyst added.
“During the pandemic, activity in this sector shot up, compensating for sectors that were having more difficulty. The low interest rates probably had a hand in the boom,” Vachon said. “Rapidly rising interest rates could seriously hurt the housing sector and drag other sectors of activity with it.
“There is also a risk of generalized financial instability. The financial markets do not work as well during times of high volatility.”
