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We have seen that, in its capacity as “a bank for banks,” the Bank of Canada can make loans to chartered banks suffering a temporary shortage of cash reserves. The rate of interest paid by the banks for these loans is known as the “Bank Rate.” In theory, a higher Bank Rate would make the banks keep more excess cash reserves in order to avoid the need to borrow from the Bank of Canada, and would thus restrict the banks’ ability to make loans and increase the money supply. In fact, this is not of any real significance, since the chartered banks only very rarely borrow from the Bank of Canada.

Rather, the importance of the Bank Rate to monetary policy has arisen from the use of Bank Rate changes by the Bank of Canada as signals to the nation of the direction of the central bank’s policies. An announcement of an increase in the Bank Rate is a signal of “tighter money,” with loans less available and more costly, whereas an announcement by the central bank of a reduction in the Bank is interpreted as signalling a movement yet the underlying economics of the situation are often quite different. If, for example, consumer demand for lumber is very high, lumber stores will find their inventories depleting rapidly and will be anxious to replenish their stocks of lumber. With the purchases for all the various lumber stores bidding actively against each other for a limited supply of lumber from the sawmills, the price will be bid up.

When the lumber reaches the retail stores, it will have a higher price – which store managers describe as “an increase in our costs.” However, the real origin of the price increases lies in high consumer demand; it is really demand-pull in nature rather than cost-push, as it appears.

In a similar way, people tend to blame inflation generally on what they can see – increases in union wages and business profits. Yet these wage and profit increases are more the symptoms of inflation, the basic cause being excess demand. Early in a period of inflation caused by excess demand, prices tend to rise faster than wages, many of which are tied to union contracts that have not yet expired; as a result, profits increase rapidly (the catch-up phase), people blame unions for the inflation. In both cases, attention is focused not on the basic cause of inflation, but rather on the more visible symptoms.

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