Increasing Interest Rates to Lower Inflation: Is it Worth the Risk?

Written By: Olivia Vanleeuwen


“On September 21, 2022, the Federal Open Market Committee (FOMC) announced that it will raise the key interest rate from 3% to 3.25% and that the rate hikes will continue (1).”

In August 2022 inflation rose to 7% which is 5 percentage points above the target inflation rate that the Bank of Canada wants (2). The Bank of Canada has decided that the best way to fight inflation is to steadily increase the interest rates until inflation decreases to its target of 2%. 

The interest rates will continue to increase, as Chair Jerome Powell said, “Before the Fed officials would consider halting their rate hikes, they would want to be very confident that inflation is moving back down to their 2% inflation target (3).” This brings to question, if the interest rate hikes, along with their impacts, are worth the potential lowering of inflation.

The Bank of Canada is hoping that by increasing interest rates individuals and businesses are discouraged from spending and loaning money, as with higher rates this becomes more and more expensive. The expectation is that with lower demand, companies will slow down their price increases in hope that this would push the consumers’ demand to increase. This in turn will lower inflation, as the costs of goods and services are increasing at a slower pace. But what are the other impacts of raising interest rates?

Canada’s Economic History

If we were to take a step back and look at Canada’s economic history, there have been three periods in which the Consumer Price Index (CPI) has fallen by at least 5 percentage points, specifically in the periods between 1974-76, 1981-83, and 1991-92. A noteworthy point here is that in every one of these instances, the fallen CPI has been accompanied by a recession (4). The graph below also validates this observation. This conveys that the strategy of rapidly increasing interest rates has, due to the recession it brings, detrimental impacts for the economy, and in turn for businesses and individuals. Are the repercussions of increasing interest rates worth the slow process of decreasing inflation?




Let’s take a closer look at the recession of 1980 and how this time frame can be a lesson for today’s economy. As seen in the graph above, interest rates were steadily increased in the 1980’s to try stop double-digit inflation. Inflation began to increase rapidly in March 1973 when President Richard Nixon disengaged the dollar from the gold standard. The gold standard was a currency measurement system that used gold as a way to set the value of money (5). This ensured that currency, under a gold-standard system, can be exchanged for gold. The removal of the gold standard allowed for inflation to increase since the printing of money was less standardised. (6). Federal Funds rates were raised and kept high. With the raised interest rates, companies were unable to borrow and spend as much money as before and with demand being lowered, job cuts were a necessity for businesses to stay afloat (7). By 1980 a recession was created, but the double-digit inflation was ended. This era in the Canadian economic history is a testament to the fact that although increasing interest rates may end inflation, a recession and other negative impacts will follow.

Will the increase of interest rates lead to a recession today? Christopher Rugaber mentioned in his Financial Post article: “… most economists say they think the Fed’s steep rate hikes will lead, over time, to job cuts, rising unemployment and a full-blown recession late this year or early next year (8).”

Impact of Raising Interest Rates on Society

Raising interest rates makes the cost of living even more expensive for Canadians. By raising interest rates, it is becoming costlier to take out a mortgage, auto, or business loan. Not to mention that if an individual already has loans, an increase in the interest rate will make their payments more expensive. People need to pay a higher amount to sustain their expenses and afford their loans, but are not necessarily making greater money to compensate for the hike. This is leading to more individuals and businesses becoming financially unstable.

The increase in interest rates discourages consumption and investments, leading to lower sales and profits which in turn forces firms to reduce output and employment (9). Raising interest rates leads to increasing unemployment which has been seen in the past. The unemployment rate in the 1980 recession was 7.5% and 865,000 people were unemployed. Since the rise in interest rates, the Canadian economy has lost a net 39,700 jobs in August 2022, with the unemployment rate rising to 5.4% (10). Businesses are unable to invest as much into their operations, investing, and financing activities since borrowing fees are steadily increasing. With the loaning and purchasing costs rising, firms need to cut down on costs, and this usually results in job layoffs. Job cuts have disastrous impacts on individuals’ lives. People can no longer afford to live or pay off their loans, leading to financial insecurity and instability.

Raising interest rates also have a massive effect on the housing market. Purchasing a house now has become more expensive than ever, since mortgage rates are increasing, and a larger down payment is needed. This makes it extremely difficult for first time homeowners to purchase a house, resulting in people renting properties instead of buying real estate. Home prices have increased to such levels that most Canadians cannot afford to enter into the market, especially given the high interest rates. As StatCanada has reported: Adults under the age of 75, especially young millennials aged 25 to 29, were less likely to own their home in 2021 than a decade earlier. This has led to more people renting properties, as the growth in renter households has more than doubled the growth of owner households (11).


In conclusion, it is clear that the Bank of Canada will continue to increase interest rates until inflation slows down and reaches its target of 2%. The steady rate hikes effect Canadians in many different ways including an increase in the cost of living, rising unemployment, creating an almost impossible to enter housing market, and also brings the possibility of a recession occurring. The Bank of Canada needs to learn from its past history and find a better mix of strategies to lower inflation.








Works Cited

  1. Board of Governors. 2022. “Federal Reserve Issues FOMC Statement.” Board of Governors of the Federal Reserve System. September 21, 2022.
  2. Government of Canada, Statistics Canada. 2022. “The Daily — Consumer Price Index, August 2022.” September 20, 2022.
  3. Rugaber, Christopher. 2022. “Fed Attack Inflation with Another Big Hike.” Financial Post, September 22, 2022.
  4. Macdonald, David. 2022. “Canada’s Fight against Inflation: Bank of Canada Could Induce A….” The Monitor. July 5, 2022.
  5. Amadoe, Kimberly. 2022. “Gold Standard.” The Balance. March 17, 2022.
  6. Lioudis, Nick. 2020. “What Is the Gold Standard?” Investopedia. September 24, 2020.
  7. Sablik, Tim. 2013. “Recession of 1981–82 | Federal Reserve History.” November 23, 2013.
  8. Rugaber, Christopher. 2022. “Fed Attack Inflation with Another Big Hike.” Financial Post, September 22, 2022.
  9. Fortin, Pierre. 2001. “Interest Rates, Unemployment & Inflation: The Canadian Experience in the 1990s.” The Review of Economic Performance & Social Progress.
  10. Gordon, Julie. 2022. “Canada Sheds Jobs for Third Month but Won’t Stop Rate Hikes.” Reuters, September 9, 2022, sec. Markets.
  11. Campbell, Shantae. 2022. Review of Fewer Canadians Own a Home: StatCan. Financial Post, September 22, 2022.



1 Comment on "Increasing Interest Rates to Lower Inflation: Is it Worth the Risk?"

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    Good article raising many valid points. One point though I wish to push back on is the decreased lack of affordability of houses for new purchasers. I believe there are two factors at play that affect affordability, the interest cost to borrow money to finance the purchase (which you mentioned) and the actual prices of houses. While rising interest rates increase borrowing costs, house prices have fallen substantially in many markets, in some as much as 30% already since rate hikes started. My only point being I believe that the falling costs of housing brought on by rising rates should have been taken into account in your analysis.

    I don’t have any issues with the other points you make.

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