Bank of Canada Decreases Key Borrowing Rate

http://www.cbc.ca/canada/montreal/story/2009/03/03/bankrate.html

Summary
The Bank of Canada has dropped its interest rate by one-half of a percentage point to 0.5 per cent. The interest rate has now been reduced by 4 percentage points since the bank commenced the latest cycle of easing in December 2007. The Bank of Canada stated that their real gross domestic product for 2009 is expected to decline by 1.2 per cent, with a rebound of 3.8 per cent in 2010. However, many critics felt that this forecast is overly optimistic. Other measures to provide monetary stimulus is also being considered by the bank, perhaps through credit and quantitative easing. The decision made by the Bank of Canada to lower its lending costs was quickly followed by a number of Canada’s big chartered banks as they lowered their prime rates to 2.5 per cent.

Connection
The main topic in Chapter 6 is Gross Domestic Product, or GDP. The GDP is affected by a number of factors, including investment and savings which significantly impacts the Bank of Canada as well as other banks around the world. During this time of economic recession, people tend to increase the amount of savings in expectation of a lower income, or losing a job. As a result, the amount of investment in the economy decreases. The Paradox of Thrift can be applied to this situation. In attempting to save more, the equilibrium RGDP is lowered. As a result, the total income earned in Canada declines, leading to layoffs as we are experiencing now. Consequently, people are not able to save as much as they intend. By decreasing their interest rates, The Bank of Canada aims to increase to amount of investments in the economy. Lower interest rates will encourage investments that were not feasible at high rates as well as provide an incentive for people to invest. While this is good for people who want to borrow money for investments, it may not be beneficial to those who want to save money.

Reflection
Personally, I would question how effective the lowering of interest rates would be on boosting the economy. While I feel that this will indeed cause an increase in investments in the economy, I think that many people will be reluctant to invest under such economic circumstances. Instead, people will be inclined to save more of their income in order to prepare for the future. Simply lowering the interest rate will not be enough to boost the economy in my opinion. The Bank of Canada must put other methods into affect to ease the decline GDP.