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What happens to the economy when central banks decide to tighten credit?


The Bank of Canada plays a crucial role in managing the economy and ensuring stable growth. One of the tools it uses is quantitative tightening, which involves increasing interest rates to control inflation and steer it back toward the 2% rate to maintain a healthy financial system. Since March 2022, we’ve seen a quick increase in the policy interest rate from 0.25% to 4.5%.  Although these adjustments might seem unrelated to your personal finances, they directly influence interest rates on mortgages, lines of credit, and other important factors in your financial life. In this article, we will explore how quantitative tightening promotes stability and discuss its impact on businesses, the job market, and the housing sector.

How credit tightening affects businesses and the jobs market

As financial conditions tighten, businesses face higher borrowing costs, leading to scaled-back investment plans and delayed hiring decisions. Reduced consumer spending due to higher interest rates further contributes to a slowdown in job creation. Business confidence may decline, causing companies to become more cautious in their hiring, resulting in fewer job opportunities and a rise in the unemployment rate. Weaker job market conditions can also dampen wage growth. The overall impact on the jobs market is closely tied to economic growth, as quantitative tightening can slow down economic activity and further suppress job creation. However, the specific effects can vary depending on factors such as the industry the business is in and the central bank's approach to tightening.

How credit tightening affects the Housing Market

When interest rates go up, it can affect the housing market in several ways. As the central bank raises interest rates, mortgage rates also increase, making it more expensive for people to borrow money for their homes. This means that potential homebuyers may find it harder to afford their desired homes or may need to choose more affordable options. As a result, the demand for housing decreases, which can lead to a slowdown in the increase of housing prices. Higher interest rates also discourage homeowners from refinancing their mortgages to get better terms, which can limit their ability to save money. Additionally, the construction of new homes may slow down as developers respond to the decreased demand and higher costs of financing. It's important to note that the impact of higher interest rates on the housing market can vary across different regions and depends on local market conditions and the overall economic situation.


In an ideal world, achieving a "soft landing" where the central bank tightens credit and slows down economic growth without triggering a severe economic downturn is the ultimate goal. However, this can be a complex challenge due to time lags in policy effects and the need to strike a balancing act between multiple objectives, and the consequences of letting inflation rise rapidly. Nonetheless, by understanding how macroeconomic changes impact everyday Canadians, we can navigate the challenges and work towards a stable and sustainable economic future. The central bank's efforts in quantitative tightening, though presenting initial challenges for businesses, job seekers, and the housing market, play a crucial role in maintaining stability and fostering an economy that benefits all Canadians. By managing inflation, controlling borrowing, and encouraging responsible financial practices, the central bank aims to support the well-being of individuals and the nation.

- Kondwelani Kalinda, Licensed Assistant

Kondwelani Kalinda is a Licensed Assistant at Endeavour Wealth Management with iA Private Wealth, an award-winning office as recognized by the Carson Group. Together with his partners he provides comprehensive wealth management planning for business owners, professionals and individual families.

This information has been prepared by Kondwelani Kalinda who is a Licensed Assistant for iA Private Wealth and does not necessarily reflect the opinion of iA Private Wealth. The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. The Investment Advisor can open accounts only in the provinces in which they are registered. iA Private Wealth Inc. is a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada. iA Private Wealth is a trademark and business name under which iA Private Wealth Inc. operates.


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