Can Cryptocurrencies Become Viable Currencies?

My write-up on whether cryptocurrencies can becomes viable currencies.




Pitfalls of Capitalism

Capitalism has been very effective in reducing poverty and ushering prosperity throughout the world. It has led to impressive economic growth in various parts of the world that has pulled people out of poverty and improved their quality of life. It has been correctly suggested in the book, Saving Capitalism from the Capitalists, that the free market system is the most potent form of economic organization to improve human condition and benefit human society. Even though capitalism or free market economy has an impressive record of improving human condition and fostering economic prosperity, it has drawbacks that need to be addressed.

Walmart is one of the largest companies and employers in the world. Also, members of the Walton family, who own a considerable portion of Walmart, are some of the wealthiest people in the world. However, a considerable number of Walmart employees have to access public assistance for their survival. According to Americans for Tax Fairness, Walmart’s low-wage workers, most of whom make above minimum wage, cost U.S. taxpayers an estimated annual $6.2 billion in public assistance that included food stamps, Medicaid and subsidized housing. This indicates that even though the wages are above minimum wage, they are inadequate to provide the workers decent living standards, which force them to access public assistance. The study found that a Walmart Supercenter cost US taxpayers between $904,542 and $1.75 million per year, which is between $3,015 and $5,815 per worker. Also, the study estimated that Walmart accounted for $13.5 billion out of $76 billion in food stamp sales in 2013, which was 18 percent of the Supplemental Nutrition Assistance Program (SNAP) or food stamp market. However, the number of Walmart employees accessing Medicaid is similar to the US national average and other large retailers.

Walmart is a large company and employer that sells goods and services to consumers at affordable prices. However, it has social costs as well. Its low wage workers access various forms of public assistance and, consequently, Walmart imposes a social burden. Even though the business model of Walmart has been very successful for its shareholders and even consumers, it has come at a social cost as its low-wage workers are forced to rely on public assistance.

The same phenomenon is observed in the American fast food industry, which outsourced a combined $7 billion in annual labour costs to taxpayers. McDonald’s accounted for $1.2 billion of this followed by Yam Brands whose workers accessed $648 million in public assistance each year. Therefore, the fast food industry, even though a profitable business model, imposes a social burden as its workers depend on social assistance for survival.

The founder and CEO of Amazon, Jeff Bezos, is the richest man in the world with a net worth of over US $130 billion. The company has 560,000 full-time and part-time employees who had a median annual salary of $28,446 in 2017. It takes the CEO under nine seconds to earn the annual salary of Amazon’s median worker. This indicates the significant difference in earnings between the CEO and Amazon’s median worker. According to Policy Matters Ohio, 700 Amazon employees, which is more than one in ten Ohio-based employees of the organization, received SNAP benefits in August 2017. While Amazon warehouses receive considerable state and local subsidies, its workers depending on social assistance increases the total subsidies that Amazon receives. This again indicates how a large organization which has many employees, has a very rich CEO and offers beneficial services to its customers, can have social costs when a considerable number of its employees seek food stamps.

On the other hand, the CEO of a technology company reduced his own salary to provide all his employees a minimum ‘living wage’ of $70,000. Even though this is an extreme example, it shows how the introduction of higher salary may eliminate the social costs a company may impose when its employees don’t have to seek government assistance for sustaining.

According to the Center on Budget and Policy Priorities, 62 percent of food stamps-receiving households are employed in low-income and part-time employment. This indicates a drawback of capitalism as the employed, even though they are low-income earners or part-time employed, seek social assistance to sustain. Also, around 66 percent of US jobs pay less than $20 an hour. When jobs pay less than $20 an hour, a considerable number of people will be financially struggling. The three states, California, New Mexico and Hawaii each have 49 percent of struggling families, which are the largest among the states. According to a report by the United Way ALICE Project, 43 percent of households (51 million households) cannot afford a monthly budget which includes housing, food, child care, health care, transportation and a cell phone.

In conclusion, capitalism has drawbacks when some of the largest companies in the world, even though are major employers, provide customers with excellent goods and services, have gargantuan revenues and very rich owners and shareholders, have considerable number of employees who need to access government assistance including food stamps for survival. The business models of these companies are excellent and very profitable; however, they impose a social burden as well. When a considerable number of their employees depend on social assistance, these companies are being effectively subsidised by the societies in which they operate and, thus, create social costs. Policies that address the issue of low wages by increasing them so that employees don’t need to seek social assistance will be suitable as it will reduce or even eliminate the social costs that these companies incur. Then, the affected employees and their families will not financially struggle and can have higher standard of living as well as be more active economic participants in the society. When capitalism is inclusive so that it works for all members of the society and raises their welfare without incurring serious external costs is desirable and sustainable.

Are there any potential problems of rising stock prices?

The financial easing programs of central banks helped to alleviate the financial crisis that crippled the world. The liquidity generated by these programs did not lead to significant increase in wages or inflation. However, the programs led to substantial liquidity entering the financial markets that contributed to the rise in stock prices. The surge in stock prices may contribute to the creation of asset bubbles, which may lead to correction in stock prices and the emergence of a bear market. This may have spillover effects on the wider economy and contribute to the potential threat of a financial crisis.

The S&P 500 is above 2,700 while the Dow is over 24,500. The TSX is over 16,000. This shows that the major stock indices are very high. The cyclically adjusted price-to-earnings (CAPE) ratio in the US is over 30, which is quite high. While the average CAPE ratio between 1881 and the present has stood at 16.8, it went above 30 only twice, during the Great Depression of 1929 and 1997-2002.–shiller-2017-09 According to Shiller, the average CAPE ratio was 22.1 in the peak time before past bear markets, which suggests that the bear market is preceded by an increase in CAPE ratio. Shiller states that a twenty percent decline in stock prices is widely accepted as an indication of a bear market. The high stock market indices and CAPE ratio indicate that stocks are quite highly priced and a bear market in the future is a possibility.

Various organizations and prominent individuals have also voiced concerns on high valuations of financial assets. Goldman Sachs suggests that there is 88 percent probability of a bear market happening based on the record of previous bear markets. ScoGen states that high valuations of stocks have been supported by low volatility and further decreases in volatility can be dangerous. Germany’s Finance Minister, Wolfgang Schäuble, has voiced concern over rising global debt and liquidity created by trillions of dollars injected into financial markets by central banks which may lead to the creation of bubbles. Professor Richard Sylla of NYU’s Stern School of Business said that similar issues like before the 2008 crisis are happening currently and he suggests that the probability of a financial crisis occuring in our lifetime is between 70 to 80 percent.

Currently, the Chicago Board Options Exchange Volatility Index (VIX) is very low, even lower than before the financial crisis of 2007. Measuring the financial markets’ sensitivity to uncertainty, VIX is known as the fear index. However, Jeffrey Frankel suggests that there are risks which are bursting of a stock-market bubble given the high stock prices and CAPE ratio or an overvalued bond-market and geopolitical risks. It is possible that investors are not taking these risks fully into consideration or underestimating them. This may lead to over-leveraging and the making of a stock market crash. Both Goldman Sachs and JP Morgan have investment products that offer clients a chance to bet on the next banking crisis. When the majority of investors underestimate the risks of a surging stock market, they may continue to chase stocks at ever increasing prices that may lead to an asset bubble. Then, financial institutions may create products to benefit their clients in the event of a stock market collapse.

The Federal Reserve has hiked the interest rate. Also, it announced that it will decrease its $4.5 trillion holdings. However, the S&P 500 and Dow have been increasing. Besides excess liquidity in the financial markets and a clear cut path followed by the Federal Reserve, the rise can be partially explained by a growing economy as well as rising profits of companies. The election of Jerome Powell as the next Chairman of the Federal Reserve may lead to continuity in monetary policy as he is viewed as unafraid of reversing the policy of decreasing the Fed’s balance sheet. Coupled with tax cuts, this will lead to the continuation of the rise in stock prices.

A financial crisis may lead to contagion effects in the wider economy and set in motion ripple effects that lead to the creation of a recession. The effects of a recession are not only economic and financial but also sociopolitical and institutional, which may linger for a longer time than the first two effects. Also, the recovery fueled by low interest rates and injection of liquidity has contributed to increasing inequality while the gains of the recovery have gone mostly to the upper-income group. Therefore, the recovery and, consequent, economic growth has not been that inclusive. Increased investments in education, human capital and infrastructure while removing obstacles like making the tax system more efficient will lead to more inclusive and sustainable growth, and lower income inequality.

When the major economies of the world especially the United States, Eurozone, Japan and China enact structural reforms, it can increase economic growth while decreasing problems in the financial sector. Economic growth will be solid, assets prices will reflect strong fundamentals while inflation will remain at a decent level. On the other hand, without the implementation of major structural reforms and a focus on excess leverage, overcapacity and tax policy geared to favour the rich, asset prices may continue to increase leading to the creation and expansion of bubbles that may rupture and, possibly, lead to deleterious effects for the wider economy.

The injection of liquidity and low interest rate has contributed to rising asset prices and sometimes, real estate prices, as in the case for Canada. Governments have taken various steps to stem rising real estate prices as well as the spiraling prices of stocks. Increases in the interest rate, tough regulations to access mortgage and tax on foreigners purchasing property have been introduced to reduce rising real estate prices in Canada. Again, the Federal Reserve has taken positive steps like raising the interest rate and a plan to reduce its massive holdings to restrain excess liquidity in the financial markets. However, structural reforms like changes in the tax policy that help the low-income and middle-class while encouraging corporations to bring home their overseas profits are required. Again, higher investments in developing human capital, infrastructure, education, healthcare, etc. while incorporating new technology to alleviate the problems in the financial sector and the wider economy will have far reaching effects. It will reduce income inequality which has been a major concern for all countries and reduce prices of financial assets. Then, asset prices will more accurately reflect the fundamentals and the probabilities of the creation, expansion and bursting of stock market bubbles will be greatly reduced. This in turn will reduce the possibility of contagion effects on the wider economy and diminish the chance of a financial crisis.

Thoughts on the proposed US tariffs

Trade between China and the US seem to be in difficulty as the US President has proposed tariffs on $50 billion of Chinese exports to the US with the threat of tariffs on another $100 billion of Chinese exports. It has rattled the stock market and may lead to a possible trade war between the two largest economies in the world that may have both economic and non-economic effects on the US. This article will explore only the economic effects. Also, the proposed tariffs may have indirect effects on Canada’s international trade.

In 2017, the US had $5.2 trillion of international trade and ran a deficit of more than $560 billion.

The US imported $506 billion worth of Chinese goods and services (which is 20 percent of total Chinese exports) while it exported $130 billion worth of goods and services to China. The large trade deficit must have played a role in the proposition of tariffs.

Rapid growth in imports from China has allowed US consumers to benefit from low-priced consumer goods. However, these increased Chinese imports led to the destruction of US manufacturing that could not compete with low-cost imports. This contributed to increased US unemployment, which are often concentrated in specific industries and geographical locations. Also, not all the unemployed workers could necessarily get employment in alternative industries. It is estimated that between 1999 and 2011, Chinese imports contributed to unemployment of 2.4 million workers. Again, research has shown that increased competition led to reduction in innovation and new patent creation in the US. As 70 percent of research & development expenditure and patenting activity in the US is in manufacturing, it can be harmful for the country.

Research has shown that Chinese companies benefit the most when they form joint ventures with US companies. However, theft of technology, lack of intellectual property rights and coercion to transfer technology has prompted concerns by the US government. While it is very attractive to access the large Chinese market, when foreign companies manufacture and operate in China, they are forced to transfer technology to the country. As these companies invest significant time and money to develop technology, this is a loss for them. Also, foreign companies operating in China have to store data in China and allow the Chinese government to access it, which again leads to tech know-how moving from the US to China.

Tariffs for China and the US are quite disproportional. The tariffs that China imposes are quite high compared to the US. While the US imposes 2.5 percent tariffs on imported cars, China’s tariffs on imported cars is ten times at 25 percent. This indicates that China needs to play its part in making trade fairer.

While there are compelling reasons for US concerns and the proposed tariffs, not bringing the trade dispute before WTO but trying to solve it bilaterally may set a bad precedence that is harmful for global trade. The proposed tariffs will make the affected Chinese imports more expensive to US consumers, which will decrease the purchasing power of the US consumers. This will particularly impact low-income US consumers who are sometimes already struggling to make ends meet.

When Chinese imports become pricier in the US due to the proposed US tariffs, Canadian exports to the US will become relatively cheaper. The relatively cheaper Canadian goods and services may make them more appealing to US consumers which may prompt them to purchase more Canadian exports. Therefore, an indirect effect of the proposed US tariffs may be increased Canadian exports to the US, which will be beneficial for Canadian exporters, workers and the Canadian economy.

The proposed US tariffs may have repercussions like China’s threat of tariffs on $50 billion of US goods. China is the third largest and rapidly growing export market for the US. The proposed Chinese tariffs will adversely impact US agriculture including its farmers and winemakers. According to the Brookings Institution, it may affect 2.1 million US jobs. Therefore, the effect of the proposed Chinese tariffs on US employment is quite considerable. Also, the trade dispute could escalate and with China holding $1.3 trillion of US Treasury securities, sale of treasury securities by China will be deleterious for the US economy. Reduced Chinese interest to purchase US Treasury securities in the future will also be harmful for the US economy.

A full-scale trade war between the two largest economies in the world will have serious repercussions for global trade, including for the US economy. It may have ripple effects that can adversely affect trade-dependent countries like Canada. However, there are some signs that the trade dispute may be improving. The Chinese premier suggested proposals to increase imports, relax foreign-ownership rules for manufacturing and improve protection of intellectual property rights. If these proposals are implemented, the trade dispute between the two countries may improve.

The US needs to improve its trade deficit as running large trade deficits for a long time may not be necessarily healthy for the economy. It has low domestic savings. In order to consumer more, it has to borrow from other countries. Therefore, policies to improve domestic savings will be helpful in reducing the need to borrow from abroad. Also, support for import-substituting and employment-generating industries can help to reduce the large trade deficit as well as improve the economy, generate employment and help the adversely affected middle-class and low-income workers. Again, increased collaboration with historical trading partners like Canada in terms of deep manufacturing and trade integration and collaboration may also help in augmenting the economy.

Concessions from China like increased market access, protection of intellectual property rights, stopping forced transfer of technology and data to joint-venture companies or the country, and relaxing foreign-ownership rules will help to improve the trade dispute. Also, issues like Chinese companies receiving state support and financing which allow them unfair advantages need to be addressed. While Canada may temporarily benefit from a trade dispute between the US and China, it will be adversely affected in the long run due to the shock global trade will suffer resulting from a trade dispute or trade war between them.

NAFTA Renegotiations and Canada

NAFTA is a 23 year old trade pact that is being recently explored for renegotiation, especially by the United States. There is even a possibility of termination of the treaty, which will affect the three countries differently and in varying degrees.

The US argument for renegotiation or even termination of NAFTA is that the treaty has led to the closure of US factories and the export of US jobs to Mexico. It is true that globalization coupled with other factors like automation has taken a toll on some industries particularly the manufacturing sector and employment in developed countries, including the US. NAFTA, which allows free trade between the three countries, has benefited the three economies in varying degrees. However, the manufacturing sector and manufacturing employment decreased in both Canada and the US while the middle class has been under increasing strain in both countries. It must be mentioned that not all of this decrease can be attributed to the implementation of NAFTA as technological innovation, automation and trade with non-NAFTA countries contributed as well.

The US rhetoric of America First would make it a rule that government projects and large-scale enterprises would have to hire US workers and use US-made resources. The objective would be to maintain or increase US industrial activity and employment particularly in industries that have shrunk. The US had a combined goods and services trade deficit of US $55.6 billion with Mexico in 2016 (US$ 63.2 billion deficit in goods and US$ 7.6 billion surplus in services) and a US$ 12.5 billion combined goods and services surplus with Canada (US$ 12.1 billion deficit in goods and US$ 24.6 billion surplus in services).  This shows that the US runs a relatively large trade deficit with Mexico. Combined with disappearing factory jobs, increasing economic constraint on the low-income and middle-class sections of the society, and rising income inequality, it may have prompted the US to revisit NAFTA.

The auto industry is very important to the NAFTA countries. While the US auto sector lost a third of its jobs since 1994 (350,000), the Mexican auto sector gained more than four times, from 120,000 to 550,000 workers. While not all US auto sector jobs were lost to Mexico, it shows the extent of losses in US auto sector employment. This has led some to blame trade deals for the job losses. In the current NAFTA renegotiations, the US wants more US content in autos.  While the current rule of origin is 62.5 percent North American content for auto parts, the US is suggesting at least 85 percent North American content and 50 percent US content for the vehicles to qualify for duty-free trade. Also, in the current rule, the content can come from any of the member countries. Industry representatives like the Canadian Vehicle Manufacturers’ Association say that the proposed rule would reduce Canada’s and NAFTA’s competitiveness. Again, the proposed rule may force auto manufacturers to move their production facilities outside of NAFTA to remain competitive and pay tariff to sell in the US market. If auto makers become less competitive and move their production overseas, it will adversely affect the economies of the three countries, lead to increased unemployment in the auto industry and related industries. On the other hand, Canada’s suggestions of calculating value of vehicles that promote using North American steel and puts importance on driverless and electric cars, and research and development work is predicted to have positive effects on North American car manufacturing and employment creation.

The US Trade Representative, Robert Lighthizer, mentioned stricter monitoring of companies’ compliance with rules of origin and stringent labour standards. Some have said that better working conditions and higher pay for Mexican workers will be beneficial for Canada and the US as it will make their production more cost effective and maintain their production levels. There have also been suggestions that the renegotiations should incorporate wages, corruption and human rights as these problems confront Mexico.–casta-eda-and-carlos-heredia-2017-09 When workers in Mexico have improved working conditions and higher pay, it will improve their quality of life as well as provide them higher standard of living. This will make trade between the three countries more equitable as workers in Canada and the US enjoy both high working conditions and pay. There has always been the argument that lower wages in Mexico have incentivized Canadian and US companies to ship their production processes to Mexico. Higher pay and improved working conditions in Mexico will reduce the incentive to move production to Mexico and increase the incentive to keep production facilities in Canada and the US. This will be beneficial for both Canadian and US economies and workers as there will be lower chance of them losing their jobs to their Mexican counterparts. Canada’s Minister of International Trade, Francois-Philippe Champagne, has said that the renegotiations should include chapters on environment, labour and gender equality. All of these will lead to improved human welfare and protection of the environment. As Canada and the US already maintain high standards, these chapters will be beneficial for their workers, citizens and economies.

Another sector that is exposed to NAFTA renegotiations is the Canadian dairy industry. The US may try to get concessions for easier entry into the protected Canadian dairy industry. Also, the US proposed a ‘sunset clause’ that would automatically terminate NAFTA in five years unless it is approved by all three countries. It will adversely affect investments as businesses will be weary of long-term investments due to the uncertainty created by the clause. This has been opposed by both Canada and Mexico, and it is expected to make renegotiations more difficult.

There is always a possibility that NAFTA may be cancelled. As supply chain is deeply integrated among the three countries, cancellation of NAFTA will hamper that chain and adversely affect Canadian and US manufacturers and workers. Jobs in Canada and the US that are dependent on exports to Mexico and job creation due to the treaty will also be adversely affected. It is possible that Canada and the US may sign a new bilateral trade agreement while the US may impose tariffs on Mexico according to its WTO standard. Also, there are talks that Canada and Mexico may remain in NAFTA even if the US leaves it.  However, better working conditions and higher pay in Mexico, chapters on environment and gender equality will be beneficial not only for Mexico but also for Canada and the US for their workers, citizens, environment and the economy. Again, Canada and the US should address the challenges of increasing income inequality, increasing income constraint on the low-income and middle-class sections of the society, and workers adversely affected by globalization, trade deals, automation, etc. Finally, irrespective of the outcome of NAFTA renegotiations, Canada should explore new trading partners and deepen its trade with existing non-NAFTA trading partners while striving to expand its trade with the US and Mexico.

Some Possible Consequences Of Toronto’s Foreign Buyer Tax

A 15 per cent tax on foreign buyers of property in the Toronto region has been introduced. This is predicted to have some consequences for the real estate market in Toronto as well as possible effects for the real estate sector in other parts of Canada as well as the wider economy. Along with the tax, the province took additional measures like expanded rent controls and allowing cities, including Toronto, to tax vacant homes.

This has had some immediate effects on the real estate market in Toronto. Sales decreased by 37.3 per cent in June 2017 compared to June 2016. Similar effects were observed in Vancouver when British Columbia introduced a similar tax. Studies have found that the percentage of foreign buyers in the Toronto real estate market may not be that substantial. Analyzing data from April 24 to May 26, the government found that only 4.7 per cent of the properties in the Greater Golden Horseshoe region were purchased by foreigners. A study by the Toronto Real Estate Board revealed that foreign buyers accounted for 4.9 per cent of real estate purchases in the Greater Toronto Area.

Again, data analysis for the same period by the Globe and Mail indicate foreign ownership of residential properties was 9.1 per cent in the York Region while it was 7.2 per cent in the City of Toronto. These analysis portray that foreign buyers, even though present, are not a dominant part of buyers in the Toronto real estate market.

Last year, British Columbia implemented a 15 per cent foreign buyers’ tax for the Metro Vancouver area. Initially, it did have the desired effect and the number of real estate transactions decreased. Also, the price of real estate declined as well. However, both sales and prices have picked up in Vancouver. In March, sales of homes in the Metro Vancouver area increased by almost 50 per cent. This shows that the impact of the foreign buyers’ tax is decreasing and may not have been as effective in stemming real estate sales and prices in the Metro Vancouver area.

The imposition of foreign buyers’ tax in the two largest cities in Canada has made the relative price of real estate in other parts of Canada cheaper for foreigners. This means that foreign buyers may start purchasing real estate outside of Toronto and the Metro Vancouver area. Even though they are not a significant percentage of real estate buyers in Toronto, it is possible that they might increase the demand for real estate in smaller cities and drive up prices in those cities. Therefore, there is a possible downside of introducing foreign buyers’ tax in only the two largest cities. There may be a spillover effect in the real estate sector in other parts of Canada.

It is possible that like Vancouver, foreign buyers’ tax may not be able to stem the rising real estate prices in Toronto. Rather than solely focusing on foreign ownership, a more effective policy would be to analyze the impact of foreign earnings and wealth on the real estate sector. When new Canadians move to Canada, they bring wealth earned outside of Canada. A portion of this wealth goes to purchasing real estate in Canada, and contributes to real estate demand and prices. Therefore, any policy to alleviate high demand and prices in the real estate sector has to focus on the influence of foreign-earned money.

Also, if there is a slowdown in purchase of real estate and a decline in real estate prices in Toronto in the short run due to the imposition of foreign buyers’ tax, it may lead to a slowdown in the wider Toronto economy. However, as has been seen in the case of Vancouver, both the sale and price of real estate increased over time after the introduction of the foreign buyers’ tax. Therefore, it is expected that the same will happen in Toronto and the effect on the wider economy will be insignificant over time.

The foreign buyers’ tax is an important initiative in the correct direction of stemming the price of real estate, especially in large cities, and making housing affordable for the average Canadian. However, it does not seem to have the desired effect in the Metro Vancouver area as both demand and price of real estate are increasing there. A better policy initiative will be to monitor the influence of foreign-earned money on the real estate sector. New Canadians consist a substantial portion of the Canadian population and bring their wealth when they move to Canada, a part of which goes to the purchase of real estate. Appropriate policies that can monitor and control the impact of foreign-earned money on the real estate sector in Canada need to be formulated to make housing affordable for the average Canadian.

How Will The Rise In Interest Rate Affect Us?

The Bank of Canada had hiked the interest rate for the first time in seven years by 0.25 per cent, from 0.5 per cent to 0.75 per cent. The increase in the interest rate will have effects on various stakeholders in the Canadian economy, including consumers and businesses. It must be mentioned that the U.S. Federal Reserve also recently increased the benchmark interest rate by 25 basis points from one per cent to 1.25 per cent.

The increase in the interest rate will provide greater incentive to Canadians to save more. The higher interest rate will lead to higher income for depositors in banks, which may encourage people to save more. However, with an increase in interest rate of only 0.25 per cent, the effect on savings is expected to be quite limited.

The higher interest rate may lead to an increase in mortgage rates. This will make it more expensive and, consequently, more difficult for existing homeowners to pay their mortgages. When existing homeowners struggle to pay off their mortgage, it may even push some towards foreclosures. Also, the higher mortgage rate may dissuade prospective entrants from delaying their house purchases. This may lead to less demand for real estate, which may have a dampening effect on high real estate prices. This will reduce the possibility of the creation of real estate bubbles or dampen an existing one.

The higher interest rate has prompted the five banks to increase their prime rate from 2.7 per cent to 2.95 per cent. The higher borrowing cost, including for credit cards and line of credit, may affect consumer spending. It may force consumers to curtail their expenditure on goods and services, and purchase less on credit. However, the Canadian economy has been performing relatively well and employment creation has been quite steady so that the possible adverse effect of higher interest rate on consumer expenditure may be negated.

The higher interest rate will increase the cost of borrowing to invest. This may make Canadian businesses less enthusiastic to borrow to invest or expand their businesses. However, the Canadian economy has performed quite well, which has allowed the Bank of Canada to increase the interest rate. So, it is predicted that businesses will borrow more to invest in spite of the increase in borrowing cost. Also, the potential adverse effect on business investment decisions due to only a 0.25 per cent increase in interest rate may not be that significant.

The higher cost of borrowing will increase the cost of production of goods and services. If businesses decide to pass on this higher cost to consumers, it will lead to higher prices of goods and services. This will increase the cost of living and may even contribute to inflationary pressures. Also, the higher prices of goods and services may make Canadian exports less competitive in export destinations. Imported goods and services to Canada will be cheaper relative to domestically manufactured goods and services, which may make them more appealing to Canadian consumers. However, the possible effect on the prices of goods and services due to a 0.25 per cent in interest rates is predicted to be quite insignificant.

Again, the higher cost of domestic borrowing may prompt Canadian businesses to seek borrowing in other countries. As the U.S. Federal Reserve increased the U.S. interest rate by 0.25 per cent as well, Canadian businesses may not particularly explore the U.S. market to seek lower rates as the interest rate differential between the two countries remain the same as before the interest rate increase. However, the effect may be quite limited as the interest rate has increased by only 0.25 per cent.

Foreign capital may flow in to take advantage of higher interest rates offered by Canadian financial institutions. It may not particularly flow from the U.S. to take advantage of higher interest rates as the interest rate differential between the countries remain the same as before the interest rate increase. However, with only a 0.25 per cent increase in interest rate, the effect on foreign capital inflow to Canada is forecasted to be not significant.

As cheap money becomes scarce and borrowing becoming expensive, it is predicted that less capital that is financed by borrowing will flow into the stock market. When less funds flow into the stock market, it will dampen the rise in stock prices and reduce the possibility of the creation of stock market bubbles or deflate an existing one.

The higher interest rate has led to an appreciation of the Canadian dollar. It was trading at 78.70 cents U.S. when the rise in interest rate was announced. However, this sudden rise in the exchange rate can be attributed to the panic created by the higher interest rate. It is expected that this sudden surge in the Canadian dollar will subside as the markets adjust to the higher interest rate unless other factors contribute to the appreciation of the Canadian dollar.

The increase in the interest rate is predicted to have some effects on Canadians. It could incentivize Canadians to save more, reduce their expenditure and borrow less than before. However, an increase of only 0.25 per cent in the interest rate is predicted to have quite limited effects on Canadians’ savings, expenditure and borrowing habits. The most profound effect of the higher interest rate is expected to be on real estate purchases.

With higher mortgage rates, the demand for house purchases may decline that may stem the rise in real estate prices. Also, the higher borrowing cost may diminish the interest of Canadian businesses to domestically borrow to finance their business operations, and increase their interest in seeking financing abroad. Moreover, the higher cost of borrowing may lead to higher prices of goods and services. But, the effects will be quite minimal as the interest rate has increased by only 0.25 per cent. The effect on inflow of foreign capital is predicted to be not substantial as well. Finally, higher borrowing cost may lead to less borrowed capital flowing to the stock market, which may limit the rise in stock prices and diminish any possible stock market bubbles.