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Aggregate Demand, inflation, and Government Action in Canada

On July 13, 2022, the Bank of Canada increases its interest rate by 100 Basis points. Let me explain why the interest rate hike will help the government fight the higher inflation rate in Canada.

Based on Macroeconomics, the aggregate demand is equal to Consumer spending plus Investment spending plus Government spending plus Net export spending (AD=C+I+G+Xn=GDP). The aggregate demand also is equal to GDP. Around 80% of the Aggregate Demand is contributed by consumer spending. I believe that decreased consumer spending is a way to help to reduce the inflation rate. As we know, Higher interest rates will encourage consumers to save more money and spend less money. Therefore, less spending will reduce the aggregate demand. In addition, higher interest rates will increase the cost of products. People will buy less or later if the prices go up. For example, consumers may decide not to buy a house when the interest rate on the loans goes up. It also will reduce the demand for goods or services relative to the new house.

In a conclusion, less consumption will reduce the Aggregate Demand, and it will move the Aggregate Demand Curve to reach an equilibrium point between the Aggregate Demand Curve and the Aggregate Supply Curve. A higher interest rate is a tool to reduce personal consumption, Aggregate Demand, and inflation rates effectively.