Money is important. We can’t function in society without it. We spend much of our waking hours working to earn it and many of our non-working hours worrying about it – especially as we approach retirement, when incomes tend to decline. We wonder if we have enough money and what the money we do have is really worth.
One way to measure the value of money is through interest rates, often described as the price of money. A risk-free investment’s interest rate determines what your money is worth. For example, if the interest rate is one per cent, $100 earns $1 annually. At three per cent, the same $100 generates $3 – tripling its yearly return.
Rising interest rates are good news for savers and lenders. Higher rates make growing retirement savings or a down payment for a home easier. Seniors relying on interest income also benefit, as their money provides more income when rates rise above the near-zero levels seen in recent years. For instance, a $100,000 savings account earning one per cent annually provides $1,000 per year. At three per cent, the same account generates $3,000 – a significant difference for retirees on fixed incomes.
However, rising rates are challenging for borrowers. Mortgages, credit cards, and other loans become more expensive. Payments increasingly cover interest rather than reducing the principal, making it harder to pay off debts. For example, a $300,000 mortgage at two per cent interest has a monthly payment of around $1,270. If the rate rises to five per cent, that same mortgage costs $1,745 monthly – a steep increase. Borrowers can quickly find themselves in a downward spiral that’s difficult to reverse.
Higher rates also discourage investment. Businesses hesitate to take on projects unless potential returns exceed borrowing costs. Some may find it easier – and safer – to invest in government bonds rather than expand operations, reducing economic growth and job creation. For example, a manufacturing firm considering new equipment may delay purchases if borrowing costs outweigh expected profits.
Falling interest rates, on the other hand, benefit borrowers by lowering the cost of debt. Loans become easier to manage, and businesses can finance more projects. However, lower rates are a mixed blessing for savers who see diminished returns and for retirees who must stretch their savings further.
Unfortunately, falling rates don’t always boost investment. Businesses may hesitate due to uncertainties such as taxes, trade policies, or economic downturns, regardless of how cheap borrowing becomes.
Inflation is another factor influencing the value of money. Borrowers and lenders need to consider the real interest rate – the rate after adjusting for inflation. For example, if the stated interest rate is three per cent and inflation is two per cent, the real rate is just one per cent. Inflation benefits borrowers, who repay loans with deflated dollars, but harms savers, whose returns struggle to keep pace with rising prices.
Another dimension of money’s value is the exchange rate. For example, how much is the Canadian dollar worth compared to the U.S. dollar or other currencies? The Canadian dollar has recently fallen from about US$0.74 to US$0.70 and may drop further.
A weaker dollar has pros and cons. On the positive side, it makes Canadian exports, including services like tourism, cheaper for the world, potentially boosting our trade balance – assuming other countries don’t impose trade barriers. On the downside, imports become more expensive, driving up costs for businesses relying on foreign goods and for consumers buying everyday items like coffee. Even a weekend trip to the United States becomes pricier.
These dynamics mean Canadians must pay closer attention to their financial decisions. Avoiding unnecessary debt, shopping carefully, and supporting local businesses are practical ways to navigate these challenges and make the most of our resources during uncertain times. Understanding the broader implications of interest rates, inflation, and exchange rates can help individuals make informed financial choices that align with their long-term goals.
Dr. Roslyn Kunin is a respected Canadian economist known for her extensive work in economic forecasting, public policy, and labour market analysis. She has held various prominent roles, including serving as the regional director for the federal government’s Department of Employment and Immigration in British Columbia and Yukon and as an adjunct professor at the University of British Columbia. Dr. Kunin is also recognized for her contributions to economic development, particularly in Western Canada.
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