Demystifying the economy | Is rising interest rates more damaging than inflation?

Every week, you send your questions on the economy, finances, markets, etc. Our journalists try to answer them with the help of experts.

” Hello to you ! I would like to understand why rising interest rates help reduce inflation. On the contrary, it increases people’s debt and causes a lot more trouble than paying a little more for our broccoli! I really don’t understand the rate hike. THANKS. » —Daniel Blanchard

According to economists, the best way to curb the rise in prices is to slow demand, and the rise in interest rates aims precisely to reduce consumer appetite by making credit more expensive.

But rising interest rates do translate into higher mortgage costs, as evidenced by the 30.5% increase in the mortgage interest cost index since the start of 2023, according to Statistics Canada.

But this index is not the only one that is taken into account in the calculation of inflation, recalls Benoit Durocher, director and senior economist at Mouvement Desjardins.

“Inflation is calculated from a basket of consumer goods and services of 250 components and each of these components does not have the same importance. It’s true that the interest costs of a mortgage are higher than the price of broccoli, but all that is taken into account.

“The important thing is to bring all the prices of the different components to an inflation rate of 2%. Even if the mortgage cost index increased by 30% last October, the weight of this index only accounts for 3.8% of the total consumer price index,” explains Benoit Durocher.

As a general rule, in Quebec, a third of households are renters, a third are owners and hold a mortgage and a final third are owners with a paid mortgage. This is why the mortgage interest cost index only accounts for 3.8% of the total inflation rate.

The entire housing sector also accounts for 28.3% of the total calculation of inflation, compared to 16.4% for transport, for example.

“But the larger housing sector includes the cost of rent, insurance, maintenance, mortgage fees, home prices, the cost of property taxes, electricity, water, gas, etc. “is much broader,” recalls Benoit Durocher.

The price of food fell in October by 0.5%, that of transport by 0.4% and that of shoes and clothing by 0.5%. Rent prices also increased in October by 8.2% compared to 7.3% in September, and here it is not the costs of mortgage interest that are at stake, but rather the effect of housing scarcity. available which continues to put pressure on prices.

So higher interest rates help generate some increase in the cost of living, but this increase is offset by declines recorded by a reduction in prices in other sectors. As we saw, last October, the consumer price index fell to 3.1% compared to 3.8% in September.

The danger, we might add, is that raising interest rates too sharply will slow the economy to the point of pushing it into recession, and that’s when we can say the remedy has caused more damage than the evil it was intended to cure.