How the Economy Works - Interest Rate, Inflation and Money Printing


We have talked a lot about money printing, inflation and interest rates.


How are these 3 things interrelated and how do they affect each other?


Today, I want to give you a simplified view of how our economy works.


Once you understand the basics, you will see why interest rate hikes are unavoidable and what the implications might be.


This could be the simplest, yet the best economic lesson for you.


If you find it useful, make sure you comment, like and share it with your friends.


At the end of the video, I will discuss one very unique factor that’s only applicable to Canada.


And this one factor may mean a slower rate hike for us compared to other countries.


So make sure you stay till the very end.


Let’s start with an economy without credit, which means no borrowing is allowed.


So your spending is essentially limited by the amount of money you have.


And the only way you can increase spending is to increase your income.


That means you need to be more productive, you will have to do more work and produce more.


Very simple, right?


Now let’s go to an economy with credit.


In this economy, your productivity and your income can stay the same, yet you can increase your spending, by borrowing.


If everyone starts to spend more, economic activity increases and we have an expansion.


Expansion is a good thing, but we have a problem here.


The increase in spending is fueled by credit while productivity did not actually increase.


The amount of goods and services are staying the same because we didn’t produce more.


But now people have more money to spend, there’s more demand for the same amount of goods and services.


What’s going to happen next?


Prices rise.


That’s inflation.


Before we talk about how to tame inflation, let’s talk about the two biggest players in our economy.


They are the Government and the Central Bank.


The Government does two things: collect taxes and spend money.


The Central Bank controls the amount of money and credit in the economy.


And they do that through two mechanisms: controlling the interest rate and printing money.


In order to stimulate the economy, the Central Bank lowers the interest rate.


People and businesses are going to borrow more because the cost of borrowing is cheap.


Borrowing isn’t necessarily a bad thing.


Businesses can use the extra money to create more jobs and more products.


Individuals can invest in themselves, upgrade their skill sets and earn more income.


There’s more income, assets become more valuable and the stock market roars.


You see, that’s how the Central Bank facilitates economic growth by lowering the interest rate.


That’s pretty straightforward, right?


Here comes the challenge.


What if we need to stimulate the economy, but the interest rate is pretty much at 0% already?


There’s no room to go any lower.


What can the Central Bank do in this case?


That’s exactly what happened in the Great Depression in 1930, the Great Recession in 2008 and the Pandemic in 2020.


Interest rate was already at rock bottom and couldn’t be lowered further to save the economy.


So the only thing the Central Bank can do is to print more money.


Let’s use 2020 as an example.


When the pandemic hit, many businesses had to shut their doors and a lot of people lost their jobs.


The Government had to give out a lot of money to help people out.


But it simply did not have that money.


So the Central Bank printed billions of dollars and lent that money to the Government by buying government bonds.


The Government then distributes that money to people and businesses in need.


Just like we said earlier, there’s more money in the economy, people are going to spend more.


But our actual productivity did not increase.


So there’s a lot more money chasing after the same amount of goods and services.


And the result is price hikes.


In fact, we have much fewer goods to work with because of all the supply chain issues.


That’s exactly why we’re seeing record high inflation rates.


Of course, a continuous high inflation rate is going to cause a lot of problems in our society.


So the Government must do something to tame inflation and that’s why you hear about upcoming interest rate hikes.


What happens when the Central Bank raises the interest rate?


It’s going to be more expensive for people and businesses to borrow money and the cost of existing debts also rises.


Obviously, borrowing is discouraged and spending slows down.


You see, the Central Bank is in a very tough position.


They need to raise the interest rate to control inflation.


But if they overdo it and people and businesses cut back too much on spending, then we would go into a recession.


Obviously, recession is the least thing we want to see as we are still recovering from the pandemic.


So the Central Bank would have to find a balance, an interest rate that tames inflation but won’t kill our economy at the same time.


Of course, the real economy is more complicated than this but I hope this simplified model gives you the underlying principles to understand the relationships among money printing, inflation and interest rates.


Countries around the world will be facing similar economic challenges as many have printed billions and trillions of dollars.


But there’s one very unique factor in Canada that may put us into a better position.


Immigration.


Previously, Canada announced a very aggressive 3 year immigration plan from 2021 to 2023, with over 400,000 immigrants per year.


The target number for 2021 was 401,000.


What number do you think we ended up achieving?


401,000.


100% on target.


How was that possible with our border closed?


Here’s the secret.


70% of those new immigrants were already living in Canada.


It’s essentially just a status change from temporary residents to permanent residents.


And there’s a big implication from that.


Typically, when new immigrants arrive from other countries, they need time to settle down and fit into the Canadian culture.


But for the “local” immigrants, they already have local Canadian training and experiences.


So they can start contributing to our labour force right away.


They definitely help to ease the labour shortage in Canada.


And that’s why the wage inflation is not rising as quickly as in the U.S.


Besides, our economy is now more productive because a bigger workforce is working to produce more.


Remember inflation happens when there’s more money chasing after the same amount of goods and services.


But now because we’re more productive, there are more goods and services available and the inflation pressure is not as high.


So we might see a relatively slower rate hike in Canada than in the U.S.


On the housing supply side of things, since the majority of the new immigrants were living in Canada, they won’t add too much pressure to the tight housing supply.


But the status change to permanent residents may increase their desire to home ownership, adding even more competition to the red hot resale market.


The current immigrant target for 2022 is set for 411,000 new immigrants.


It seems that the government may want to increase the target even further.


I will definitely keep you posted as immigration is a major factor that would affect our housing market and the overall economy.


I hope you find this video valuable and now have a better understanding about money printing, inflation and interest rates.


If you like this kind of video where I share knowledge on the bigger picture of our economy, make sure you subscribe and hit the bell so you keep getting valuable content.


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