Jun 7, 2023

The Bank of Canada’s obsession with interest rate hikes is hurting households: How did we get here and what are the alternatives?


The Bank of Canada’s June decision to raise its overnight, or policy, interest rate to 4.75% is predicated on cooling an overly strong economy afflicted by stubbornly high inflation. Yet, it’s not at all clear that the Bank’s narrative makes sense and, in one major category, housing, higher interest rates will make inflation worse by raising the cost of borrowing for homeowners with mortgages.

This post looks more closely at the inflation we’ve had over the past year plus. In short, Canada’s inflation experience has largely been the result of external factors, in particular spiking oil and gas prices due to Russia’s invasion of Ukraine and temporary supply chain impacts as economies emerged from the COVID-19 pandemic. 

As these factors have abated inflation has decreased. After peaking above 8% last year, inflation in April was 4.4% nationally and 4.3% in BC, while the Bank expects inflation to fall to 3% this summer. In place of interest rate hikes, alternative policies should be on the table to challenge corporate profiteering and support households struggling to make ends meet. 

Competing stories about inflation

The inflation crisis for most households is largely about transportation, housing and food, and in each area jacking up interest rates has been either ineffective or made the problem worse. This is most acute in housing where Bank of Canada rate hikes mean both higher monthly payments for many households with mortgages and longer timeframes needed to repay the debt. For example, on a variable rate mortgage of $500,000, rate hikes since March 2022 represent an extra $22,500 per year in interest costs. 

A number of false narratives about inflation have taken hold over the past year. The most dangerous line is an old monetarist staple that inflation is simply caused by “too much money chasing too few goods.” The Bank of Canada’s version of this is that there are too many workers making and spending too much money. In this view, higher unemployment is desirable as it will reduce demand and lower prices. 

Interestingly, the recent fall in inflation occurred while employment was much more robust in the face of interest rate hikes. Nationally and in BC, the unemployment rate was 5.0% in April, little changed since last year. 

Another incorrect claim is that inflation is caused by too much government spending in the form of income transfers funded by large deficits, meaning that further government efforts to help those most affected by rising prices will be counter-productive. 

A number of false narratives about inflation have taken hold over the past year. 

Thus far, federal and provincial affordability supports have been modest and are unlikely to have caused further inflation. Looking back over the COVID-19 shutdown period, when income supports were at their highest, inflation was not a problem. Indeed, those transfers back-filled income that would otherwise be lost, allowing households to maintain some (but not all) of their previous consumption. Such measures to boost demand in recessionary times are a staple of good fiscal policy.

Finally, the carbon tax has been targeted as the source of inflation. While it is true that carbon taxes have been steadily increasing, the federal (and BC) carbon price only increased by about two cents per litre as of April 2022 and, in total, accounts for 11 cents per litre at the pump ($50 per tonne of CO2). 

In contrast, Vancouver pump prices surged from an average of $1.56 per litre in November 2021 to a peak of $2.25 in June 2022, a jump of almost 70 cents per litre. These price hikes from the market were a big source of inflation in 2022, while prices falling back down by the end of 2022 contributed significantly to  the recent drop in inflation.

Figure: Key energy components of BC inflation (July 2021 = 100)

Note: This figure shows different energy components of inflation starting in July 2021. Costs for BC Hydro electricity (yellow line) were not a driver of inflation unlike gasoline (green) and natural gas (blue) prices.
Source: Author’s calculations based on Statistics Canada, Consumer Price Index, monthly, not seasonally adjusted, table: 18-10-0004-01.

It’s not taxes but spiking energy prices in the aftermath of Russia’s invasion of Ukraine that have been a major source of inflation. Oil and gas prices have always been more volatile due to geopolitical tensions, supply disruptions and speculative behaviour. Because they are a significant input into all other goods and services, fuel price shocks ripple through transportation, manufacturing and other sectors.

This energy price shock was exacerbated by post-COVID-19 rebound effects and bottlenecks that affected supply chains around the world. Those temporary sources of inflation have largely passed, although increasingly disasters due to extreme weather and climate change are impacting supply chains (see our report on BC’s 2021 extreme weather). 

Higher food prices are a good illustration of the flaw in the too-much-demand argument about inflation. The notion that food prices jumped because people were eating too much or more than they did in the past simply does not make sense. 

Food price hikes are a supply-side story. Higher fuel costs manifest in higher costs for on-farm energy use and fertilizers and transportation to market. In addition, the food industry is highly concentrated in many areas and where they have market power producers and retailers can and will jack up prices. 

Alternative anti-inflation policies 

Rather than put the blame on workers, challenging the role of corporate profiteering should be at the heart of an anti-inflation strategy. Big grocery chains did more than just pass along higher prices from their suppliers: they added a little extra padding at the supermarket till. This is reflected in big increases in profits for Loblaws and other chains. 

The affordability crisis is truly embarrassing when we add in the $35 billion in windfall profits made by oil and gas companies from higher global prices passed on to consumers. For these companies, their underlying costs of production did not change so price increases are pure profit. 

Putting a windfall profits tax on such earnings would not affect any investment decisions, but would raise money that could be transferred to households that are struggling to make ends meet. 

On that note, recent federal and BC affordability supports could have been better targeted to low-income households that are bearing greater costs. Across-the-board rebates for BC Hydro ($100 per customer) and ICBC ($110 per driver) are costly ($300 million and $400 million respectively) and could have more dramatically reduced poverty had they been targeted to low-income households. Separate targeted measures from the BC and federal governments combined were $400 for a low-income single individual and $1,227 for a low-income family of four. 

Over the medium term, getting off fossil fuels would protect households from energy price shocks. We have an imperative to do this to meet our climate obligations and much more needs to happen to accelerate the transition now, as record wildfires fuelled by climate change have been telling us. 

Rather than blame workers, challenging the role of corporate profiteering should be at the heart of anti-inflation strategy.

In contrast to pump prices, BC Hydro provided a stable supply of clean electricity at no additional cost per kWh over the past two years. As a public utility whose prices are regulated, BC Hydro energy is reliable and stable and about as clean as you can get in terms of carbon emissions. 

While BC’s electricity grid is already rich with hydropower, efforts to decarbonize buildings and transportation are needed to reduce the demand for fossil fuels. This is obviously more necessary for low-income households, many of which are renters and are more reliant on public transit. In housing, publicly-supported energy programs aimed at multi-unit buildings (such as older purpose-built rentals) and covering 100% of upfront costs should be on the retrofit agenda.

Thinking big would mean going beyond EVs and retrofits toward integrated planning for zero-carbon, multi-unit affordable rental housing buildings and big investments in public transit and walkable/bikeable communities. These point to deep emission reductions to meet our climate targets on the one hand and affordability and insulation from external price shocks on the other. 

The bottom line is that interest rate hikes are a blunt tool that likely played a little role in the recent decline in inflation. Even when they work as intended, rate hikes can only contribute to bringing down inflation on the backs of workers through higher unemployment and lower wages. Public investments to address the intersection between climate action and affordability need to be a much bigger part of the policy tool kit, accompanied by strong measures to prevent corporate profiteering.