Explain why the article is providing weak ination and the possibility of NAFTA’s

Question

Explain why the article is providing weak ination and the possibility of NAFTA’s end as motives for not increasing the interest rate. In other terms, if there was a new interest rate hike, how would prices be aected? (hint: think of the relation between money supply and prices) and what would happen if the Bank increased the interest rate and on top of that NAFTA collapses? (hint: think of the eect of the interest rate on ER)

BoC puts rate hikes on hold amid weak inflation, threat of NAFTA collapse The Bank of Canada is suddenly in no hurry to push interest rates higher as it grapples with a raft of uncertainties, including the possible end of NAFTA, slowing growth and a puzzling lack of inflation After two quick and largely unexpected rate hikes in July and September, the central bank hit the pause button on Wednesday, opting to keep its benchmark interest at 1 per cent. Among the challenges facing Mr. Poloz is that while the economy is already running close to full capacity, inflation and wage growth are muted. Indeed, the bank said inflation won't get back to its 2-per-cent target until the second half of next year because of the recent strength of the Canadian dollar. The dollar is up nearly 8 per cent since May, even after Wednesday's decline. The bank has also ratcheted up its concern about the Trump effect on Canada's export-dependent economy. Rising protectionism in the United States is now "the greatest source of uncertainty" clouding Canada's economic outlook, the bank warns in its latest monetary policy report, also released on Wednesday.

Explanation / Answer

Effects of interest rate (call it i) on :-

1). Prices : i is increased to limit money supply. It is called contractionary monetary policy. This helps in controlling price rise and slowing down economy. This is so because of the direct relation between money supply and prices. With higher money supply, there is more demand and if adequate increase in output is not realized , we see rise in prices.Similarly, here by increasing i, we have reduced money supply leading to lower inflation. The article is saying that inflation nd growth , both are already low. Therefore, any further increase in i can worsen the situtation.

2). Exchange rate: Higher i leads to foreign capital inflow which strengthens canadian dollar. Given that it is already up by 8% , there is no reason to increase i further as then canadian dollar would appreciate further and would make its exports costlier. As canada is export driven economy, it cant afford to lose its export competitiveness. Also if NAFTA collapses, then US would put high import tariffs which can further discourage canadian exports.

Therefore, there is no case for further increase in i.

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