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What's the policy interest rate?

Andrew Goldman

Andrew Goldman has been writing for over 20 years and investing for the past 10 years. He currently writes about personal finance and investing for Wealthsimple. Andrew's past work has been published in The New York Times Magazine, Bloomberg Businessweek, New York Magazine and Wired. Television appearances include NBC's Today show as well as Fox News. Andrew holds a Bachelor of Arts (English) from the University of Texas. He and his wife Robin live in Westport, Connecticut with their two boys and a Bedlington terrier. In his spare time, he hosts “The Originals" podcast.

Three more sleep inducing words have perhaps never been strung together, but the policy interest rate is actually pretty exciting insofar as it's a little number that has a profound effect on a country’s entire economy. The policy interest rate — often referred to as the overnight rate — is what banks charge one another to borrow money in order to maintain federally mandated cash reserve requirements.

The importance of this money to the economy can’t be overstated; it’s the gasoline that fuels the economy’s engine. Unlike, say, mortgage rates, banks have absolutely no control of the overnight rate. It’s dictated by the Bank of Canada’s Governing Council, the six-member body that meets eight times a year and decides if it wants to raise, lower, or keep unchanged the rate. (Whenever you hear breathless speculation in financial circles about whether the Bank of Canada will raise or lower interest rates, it’s shorthand for this process.) Any change in the policy interest rate will have seismic effects in the economy. A lowering of the rate, undertaken in order to goose a sluggish economy, frees up the spigot of money by making interest rates in all manner of loans cheaper. Businesses expand, homebuyers buy, and stock markets generally rise.

Conversely, a rate hike — which turns down the flow of money through the economy to prevent inflation — generally slows things down, and depresses the stock prices of most publicly traded companies. Banks, who can rake in more revenue by collecting higher interest rates on loans, are one of the few exceptions.

Last Updated March 6, 2018

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