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Interest Rates & Inflation
Interest Rates
&Inflation
Interest Rates
What is interest?
• Interest is a fee charged on money that is borrowed
• The interest rate is a percentage of money that the lender wants to gain from the investment
• Interest is usually calculated annually• The calculations involve the money borrowed,
the interest rate, and the length the money is borrowed for
Types of interest
There are 4 main types of interest rate: 1. Simple Interest2. Compound interest 3. Fixed term interest 4. Variable term interest
Simple Interest
• Most basic type of interest• The formula for calculating simple interest is
I=P*R*T• I- Interest• P- Principle • R- Rate• T- Time
Example of Simple Interest
• If TD is offering a 5% return on investment, for a 3 year term, what would be the interest collect at the end of the term if $10,000 is invested?
• $10,000*5%/100*3=I• I=$1500
Compound Interest• Grow at a exponential rate• A=P(1+R/N)^NT • A- Amount at the end of investment• P- Principal amount • R- annual interest rate• N- Number of time the interest is
compounded per year• T- Time( number of years)
Fixed term Interest
• Fixed term interest has a constant interest rate which does not change
• A Fixed term interest rate would not be affected by any economical events such as inflation
• Usually Fixed term interest are used in mortgages
Variable Term Interest
• The interest rate will vary during term• Considered as a low risk investment• Credit cards are mostly based on variable
interest• The rate of interest during the term is based
on inflation and other economical events
What types of inflation do you believe is the most
effective in this economy?
Article.Topic: Current concerns
Reuters:“Bank of Canada sees rebound modest versus past ones.”
http://www.reuters.com/article/bondsNews/idUSN2515976720091025
Article
• Canada’s economic recovery is under way, more modest than historical norm
• CAD$ inflation is a target key factor in setting policy
• Canadian corporate balance sheets are strong
Bubbles Caused by Interest Rates
What is bubbling
• Bubbling is a situation where market prices are unsustainably high.
• bubbling is when the quantity is low and the demand is high.
• Bubble is not a good thing to have
Examples of bubbling
• Housing market (2007)
• Tulip mania (1637)
• Railway Mania (1840)
• Sports cards and comic books (1980- 1990)
How Bubbles are caused by interest rates in the US
• The housing bubble began inflating in the mid-1990s
• Dozens of mortgage firms, tens of thousands of jobs on Wall Street and the dreams of about 1 million proud new homeowners who lost their houses
• When the housing market's collapse it rumbled through the economy, with unemployment rising, companies can’t obtain financing
How Bubbles are caused by interest rates in the Canada
• In Canada House prices have actually increased in some provinces and now there is a shortage of houses for sale in southern Ontario.
• Total mortgage credit in Canada will grow by 12-14 per cent in 2009
• In Canada 90 per cent of mortgages in Canada are "securitized." That is the practice of pooling mortgages and then issuing new securities backed by the pool
In what way do you believe that Canada`s current housing bubble can be deflated without major
losses on the part of the Canadian public?
Stagflation
What is Inflation?
• Prices were very cheap in the past• Risen throughout years• Cause: Inflation Rise in the general level of prices of goods and
services in an economy over a period of time When price level rises, each unit of currency is able
to buy fewer goods and services;
Stagflation
• Stagnation + Inflation = Stagflation• A period where the economy is very slow + The
continuous price increases = Unfavorable economic condition
• Economy is slowed by unfavorable shock• Ex: Increase of price in oil in oil importing country
• Can also result from inappropriate macroeconomic policies
• Inflation = excessive growth of money supply • Stagnation = excessive regulation of goods markets and labor
markets.
Stagflation in 1970s
• Stagflation appeared in 1970s• Horrible chain of events
• consumers expected continuous increases in prices resulting in heavy spending• Increase in demand, increased the prices• Increased prices lead to demand of higher wages• Demand of higher wages, pushed prices even higher• Never-ending upward spiral
1970s cont…
• Attempt of government to keep track of payments such as Social Security and Consumer Price Index
• Helped workers to fight with inflation for a while
• With passage of time, government required more funds and thus needed to borrow = even higher interest rates
Stagflation 1970s- Solution
• President Jimmy Carter (1977-1981) took some desperate steps.
• Increased government spending• Voluntary wage• Price guidelines
• Plan did not work• 1980s, the government of United States loosened the
controls on bank interest rates. • Country forced through several years in recession
Cause of Stagflation (1970)
• OPEC oil crisis • Organization of Petroleum Exporting Countries
decided to raise the prices of oil dramatically and cut back on supply
• Proved as major shock sending economy into period of stagflation
• In Canada, inflation climbed to over 10% in 1974 and 1975
• Unemployment increased to 7% by 1975
Discussion Question- Stagflation
What measures can the government take in order to keep Stagflation from occurring
again?
Auction for SurvivalITEM WINNING BID WINNING GROUP
Water Bottles
Dried Chicken and Beef
Juice Boxes
Chips and other Snacks
Soya Milk
Vegetables and Tofu
Group 1 Group 2 Group 3 Group 4 Group 5 Group 6 Group 7 Group 8
1000000 1000000 1000000 1000000 1000000 1000000 1000000 1000000
HYPERINFLATION
Hyperinflation Case: Zimbabwe
• The first country to hyper-inflate in the 21st century
• Reached 79.7 billion% monthly inflation rate in November 15th, 2008
What causes Hyperinflation?• Hyperinflation is caused
by large increase in the production and supply of paper money
• Monetary and fiscal authorities of a federal government issues large quantities of money to pay for projects
• In May 2006, Zimbabwe announced the printing of 60 trillion ZW$ to finance salary increase for civil workers
•Hyperinflation cause by the government is just another form of taxation commonly called the “inflation tax”
Annual inflation rate of Zimbabwe
Buying power!• The real quantity of money
is also known as the buying power
• High inflation encourages families to sustain higher wealth in items rather than cash to avoid inflation tax
• But as people buy more, the prices continue to inflate
• On July 18, 2008, it cost 150 billion ZW$ to buy 3 eggs
Chart Showing Quickly Inflating ZW$
A Vicious Cycle...• On February 16, 2006,
governor of the Reserve Bank of Zimbabwe announced that they were printing 20.5 trillion ZW$ to pay national debt
• Hyperinflation worsened as they attempted to print more money to pay off debt
• Continuous increase in inflation meant that they had to print even more money than planned to pay off the same foreign debt
How to stop Hyperinflation
Hyperinflation can be stopped if• The government promises to stop printing
more money and putting it into the system• The government creates a new fiscal budget
to ensure it takes away the incentive for the government to resort to inflationary taxation
• The Zimbabwe government has transitioned out of their dead currency in order decrease the inflation rate
Zimerica a.k.a. Ameribabwe• America itself is at risk of
growing inflation rates• Forecasted 2.5% inflation
rate for 2011 in America, 0.5-0.8% higher than preferred range of central bank
• Refusal to raise interest rates due to high unemployment rate will cause debt and inevitably, inflation
• 11.4 trillion dollar national debt will continue to increase
So...
What can people do to fight future inflation issues? Are ideas like investing in gold as an inflation hedge a good
idea?
Central Banks&
Inflation Targeting
Central Banks
• Responsible for creating a stable financial environment
• Each country has their own
Central Banks
• Interest Rates• Bank can buy or sell government securities to
the private sector to reinforce the interest rate• Providing liquidity to banks on a day-to-day
basis
Inflation Targeting
• A process by which the inflation is held within a published range.
• Transparency is necessary
Without targeting With targeting
Inflation Targeting
1% - 3%2%
Inflation Targeting
• Based on Consumer Price Index.• Pros: – It stabilizes the entire economy.• Investors• Average Families
– No guessing involved.• Cons: – Other monetary policies are not adhered to, such as
full employment, and avoiding a recession.– Central bank can become too weak and inflexible to
react to huge shocks, such as a sudden recession
Current Inflation
Target Inflation
Interest Rates
$
Current Inflation
Target Inflation
Interest Rates
$
Do you think that inflation targeting should be a
major priority of the Bank of Canada?
The End
