Although increases in the target rate are commonly associated with increases in the cost of investment, examining the benefits of target rate increases is crucial to understanding its impact on the Canadian economy. The Key Lending Rate also affects mortgage interest rates.
Firstly, a higher rate stimulates sectors of the economy that may experience slow growth when rates are low. As an example of a low rate running rampant, before the real estate meltdown, the United States real estate sector accounted for approximately 40% of job creation. This is because the low lending rate led to huge increases in investment into the real estate market. As expected, the housing bubble burst, and the American economy still feels the effects today. When the lending rate increase, however, other industries such as the manufacturing and service sectors are able to compete with the real estate sector for labour, thus creating a stronger and more balanced economy.
Secondly, higher rates lead to increased saving due to the incentive of higher yields. This could lead to Canada`s recovery from the recent borrowing boom.
Lastly, a lending rate that is too low does not allow room for the Canadian government to implement monetary policy in a time of crisis. Increasing the lending rate, however, allow for potential rate cuts during a financial crisis. The reduced rate would stimulate investment and spending, thus leading to economic recovery.
Read a full description of the effects of the rate increase here.