The central bank’s increase the interest rates provokes the rate of investment and consumer spending to go down. As a result, aggregate demand (AD) will decline as seen between AD1 to AD2. The effects of lower aggregate demand are as follows: first, the rate of economic growth will decrease or stagnate. The fall in economic growth is depicted by a decline in the gross domestic product (GDP) as represented by the fall from Y1 to Y2 in the diagram. Secondly, the rate of unemployment will go up. The reason is that when output declines, firms produce fewer goods and therefore there will be lesser demand for workers. Thirdly, the current account of the Canadian economy will improve. With higher rates expenditure on import declines and the lower inflation rate assist in enhancing competitiveness for exports.
Figure 2: effect of an interest rate cut
The bank of Canada in this article chose to maintain low interest rates to promote economic growth and stability, with a final goal of an expanded economy. Reducing the effects of high interest rates could be done by reducing the interest to equilibrium level, in sync with the current economic situation or a halting the current hikes to allow a corresponding economic expansion. Reduction in interest rates by the central bank encourages the business community to take more loans which are reinvested into the economy. The improvement in the investment improves economic growth as depicted by the increase in GDP from Y1 to Y2 as modelled in Fig. 2. Moreover, low interest rates