Inflation, a rise in the average level of all prices, is a problem that can affect both developed and undeveloped countries. It occurs when the economy is producing at or near full capacity. As inflation increases, the purchasing power of the dollar decreases. As prices rise, wages and salaries also have a tendency to rise.

More money in people s pockets causes prices to increase even higher. This can make it hard for consumers to catch up. Inflation can occur at any time and like any other problem, there are both gainers and losers. Continued inflation can affect people in different ways. Those who live on fixed incomes suffer the most because the are not able to buy as much. Those who lend money when prices are lower may be paid back in dollars of reduced purchasing power.

Banks and savings and loan associations also tend to lose from inflation. Should inflation continue for a long period of time, the country as a whole may begin to invest less and consume more, as people find it more profitable to borrow than to save. Therefore, it can be said that inflation tends to cause societies to use more of its resources for today s purposes and sets aside less for tomorrow s needs. This is a matter of concern for the Bank of Canada. In order to stop inflation from becoming a problem, the Bank has issued a proposal of increasing interest rates. In recent months there has been growing evidence that the Canadian economy is expanding rapidly and absorbing unused capacity.

Bank officials, from the Bank of Canada, have said they believe the economy is proceeding at slightly more than 2% below full capacity. They also believe, that should that gap close, they will have to raise interest rates as a way of forestalling future inflation. The central bank has said they will take whatever action necessary to prevent inflation from rising above 3% a year. Ideally, they want to keep inflation levels between 1 and 3 percent. Bank official Paul Jenkins, believes that the end result will be A better functioning Canadian economy, one that operates at full capacity with low inflation. The low inflation, the price stability, facilitates a much better functioning Canadian economy: you avoid the boom-bust of the 70 s and 80 s.

The Bank of Canada expects the Canadian economy to grow at a 4% annual clip. 2 While this proves beneficial to the Canadian economy, it could also cause Canada to grow too big too quick unless interest rates increase. All of our resources are being used up. People are borrowing money from the banks at accelerating rates. Increasing interest rates will cool off this hot economy but will not kill the ongoing recovery process from the early 90 s.

Financial Minister, Paul Martin, agrees with the Bank of Canada saying, Interest rates are needed to avoid inflationary pressures and the need for greater return down the road." Economically speaking, with an anticipated increase in interest rates, there will be an increase in the amount of stocks and bonds purchased. The social trade-off is that people are not going to buy as much. This means prices will drop and inflation levels will decrease. Even with high interest rates our country can operate at full potential. It just eliminates the negative effects of inflation. It may not seem like the best idea right now, but the central rule of thumb in banking is that changes in monetary policy take a least a year to have impact on the economy, which means, this month's rate is aimed at applying the brakes late next year and beyond..