floodgate interest rates

weir_wide.jpg
Here’s a wider view of the weir. See if you can see, in it, where the previous photo came from.
I’ve been using this weir as a metaphor for monetary policy’s use of interest rates recently. As mentioned, the weir is used to regulate the level of the river and lake by providing more or less water based on the angle of the weir spillgates themselves. Lets break down the roles involved quickly:

  • lake = Bank of Canada reserve
  • weir spillgates = interest rate
  • river = economy

First lets explain why the weir is even there in reality. The river (update: the river flows FROM the lake) needs a decent level in order to operate effectively downstream. The river levels would be higher than necessary in the winter – when rain is plentiful and evaporation is minimal, so the weir levers would be relatively higher, but still open since they don’t want the lake to flood. In the summer, when river levels would otherwise be very low, the lake has enough water in it to drop the spillgates and provide more flow. This is important for many aspects of the river, not the least of which is fish and keeping the river relatively clean. This is the business of the river. Without water, things don’t move so good.
In Canada, we have an institution that manages the supply, cost, and availability of money. This institution lends to the banks, who then in turn lend to people and organizations for things like buying houses etc. This institution is called the Bank of Canada (BoC.) The banks base their interest rates for lending a little higher than what they can get from the BoC.
The BoC raises the interest rate (floodgates) to contract the money supply (increases level in the lake) to encourage saving. The BoC lowers the interest rate (floodgates) to encourage spending (increasing the level of the river, allowing more activity) – this happens since the cost of money is decreased through a lower interest rate.
So there you have it, an explanation of why the BoC dropped the interest rate to 0.25% this morning – it’s to open up the floodgates a bit, add some flow to the river, encourage spending and combat the recession.

5 thoughts on “floodgate interest rates”

  1. It’s too bad the weir only works if the river is at a certain level. Right now, the river is drying up and desperately needs a massive rainfall (ie. stimulus)

  2. Thats sort of right – maybe I didn’t do a good job of explaining that the lake flows into the river and out to Cowichan Bay. It’s more dependent on the lake level, which is dependent both on the weir level and rainfall (stimulus).

  3. Yes, a weir controls the perpetual rate of flow of water, and also maintain the horizontal profile of a river (so that there aren’t unwanted rapids or falls). We have one in Calgary which helps prevent flooding of the Bow River in low-lying areas.
    Weirs are kind of like dams, but they don’t stop nor pool water like dams do.
    And this has been another Canadian Heritage Moment.
    (cue music)

  4. BTW I think the way it works is as follows:
    The Bank of Canada dropped their interest rate (to banks) by 0.25% to 0.25%. That’s it. That’s all the BoC is charging banks like RBC and BMO to lend money to you and me. What those banks are in turn charging you and I is 2.25%, meaning RBC, BMO and the like are making 2% interest on us.
    With the prime lending rate down at 0.25%, the fear is that there’s little influence left for the BoC to exercise if this doesn’t work. It’s like having the floodgates wide open, people walking on the river bed with brooms, pushing the puddles downstream…
    Doesn’t matter how wide open the gates are, if there’s no water in the river.

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