Wow, here we go again with rising gas prices caused by political instability in the Middle East. What's more, global food prices are expected to rise sharply partly as a result of Americans using corn and grain to produce ethanol for gasoline.
Which, by the way, is subsidized by the U.S. government, I mean the U.S. taxpayer.
Rising gas and food prices means rising inflation. Rising inflation means the Bank of Canada will use the only tool it has to keep inflation within its arbitrarily set one to three per cent band - it will raise interest rates.
The BOC has been itching to raise the rates for quite some time now but has been held back because raising rates before the Americans do means the Canadian dollar goes up, and that hurts the export sector of our economy.
The problem with raising interest rates in response to "price push" inflation is that it doesn't work. This debate came up back in the 1970s when CPI increases were running in range of 14 or 15 per cent.
To hammer this down, interest rates were jacked up so high they nearly killed the economy. Some folks with variable mortgages or untimely renewals found themselves facing rates above 20 per cent. The lucky ones who were mortgage free or still enjoyed some of those sweet locked in six per cent mortgages never knew there was a problem.
The way raising interest rates are supposed to squelch inflation is by shrinking the money supply - the cash in circulation.
If inflation is caused by external price shocks like rising gas or food prices how does shrinking the money supply keep those prices down?
Raising interest rates to fight inflation only works in an overheated economy where profits and wages are rising so fast they are creating "demand pull" inflation.
Next time you are filling up your gas tank, ask yourself if the solution to rising gas prices is to increase interest rates.
Then if your mortgage rate goes up call your MP and ask them to explain it.
Roy Olsen
Prince George
