How to Combat an Inflationary Environment
Interest rates have been a big topic lately. The current rate set by the Bank of Canada, BoC is 2.5%. This is the interest rate at which banks borrow from the BoC. Now the banks also need to make money so they charge their own interest rate to you when you borrow from them, and that's what's called 'prime'. Back in the 90's interest rates were in the double digits, 14%, so we are still looking good and it will take a collective effort to bring interest rates back down again. What does this mean and why is this happening?
Why is the happening?
The market has been hot and the firefighters have been called. COVID started and the government dumped a lot of money into the economy. Not only did they dump a lot of money into the economy, they practically gave it away for free, 0% at one point, in this low interest rate environment. With the influx of money, people were spending more, although there may not have been enough supply to handle it all. Therefore, sellers increase their prices to offset the demand. This increase in pricing is what drives inflation.
Now, the government is out to cool this hot market because pricing will continue to increase, so in order to achieve this, they increase the cost of borrowing in hopes that people will think twice about borrowing and spending. This in turn will slow the demand, lower the cost of goods and thereby increase supply. It's a big cat and mouse game of supply and demand to achieve market equilibrium.
Here are some of the effects of inflation on an economy
Benefits of Inflation
Allows for wage adjustments
Allows for price adjustments
Erodes the value of debt in an economy
Increases the value of assets
Increases access to funds, benefiting borrowers
Drawbacks of Inflation
Increases cost of goods and services
Increases industrial action due to workers demanding higher wages to offset a fall in real wages
Erodes purchasing power
Reduces savings and the value of savings
Leads to reduced production
What does this mean for you?
If you are holding a variable mortgage or variable loan like a line of credit, you may begin to see your monthly minimums increase because interest rates have increased. Now more than ever you want to be prudent and disciplined with your finances. It may get worse before it gets better. Here are a few things you can do to combat an inflationary environment.
Focus on eliminating all variable debt as soon as possible.
Focus on saving and building your emergency fund
Focus on sticking to your budget
Focus on increasing your income
Tough times never last, tough people do ~ Robert H. Schuller