Interest Rates, Inflation & the Risk of Doing Nothing

For those old enough to remember, the late 1970s and early 1980s were periods rife with high inflation and interest rates. In 1981, inflation rates reached over 12 percent and the now defunct Canada Savings Bond returned 19.5 percent interest.1 While high interest rates meant great returns on low-risk assets like guaranteed investment certificates, it also meant unaffordable mortgages! 

Since that time, it has been widely recognized that the central banks are responsible for keeping inflation in check as part of their policy objectives. For many years, the Bank of Canada and U.S. Federal Reserve (Fed) have targeted a two percent core inflation rate. Over the last decade, inflation has generally hovered close to this target, due to monetary policy actions as well as persistently low price and wage increases. It should be noted that the measure of core inflation doesn’t include some of the more volatile components of our goods and services, such as food and gas — everyday costs incurred by most individuals. Many Canadians would argue that food costs have largely outpaced core inflation rates! 

Today’s Realities: Low Interest Rates, Low Inflation 

Of course, it is unlikely that we will see the return of the inflation rates experienced in the 1970s. However, even moderate inflation can have a significant impact over time. The chart shows the erosion of purchasing power of $100 with just moderate inflation rates. 

Chart: Even Moderate Inflation Can Erode Purchasing Power 

 Inflation Rate 
Year 1% 2% 3% 
0 $100 $100 $100 
10 $90.53 $82.03 $74.41 
20 $81.95 $67.30 $55.37 
30 $74.19 $55.21 $41.20 


This should also remind us of the value in investing funds for the future. With interest rates at near-zero levels, many savings accounts yield paltry returns. Add in the subtle effects of inflation and doing nothing with your money can have its own risks. 

While the effects of the pandemic may have created short-term deflationary pressures, there are differing views on the longer-term path for inflation. With central banks pledging to keep interest rates low for the foreseeable future, there is the potential for rising inflation — traditional economics suggests that when rates are low and the economy grows, inflation generally increases. As well, in 2020 the Fed signaled a major shift in its approach to managing inflation, now allowing it to run above the previous two percent target. This significant change in policy stance was undertaken to try and stimulate growth and tackle unemployment as a result of the pandemic. 

1 Bank of Canada monthly historical CSB rates and CPI.

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