Wednesday's double-barrelled attack on inflation may fall short as markets gyrate

While Canadians wait to see whether interest rates really will begin to rise tomorrow, it might bereasonable to askwhat all the fuss is about.

As a friend commented last week, when we were discussing thedouble-barrelled pronouncements on inflation and interest rates from both Ottawa and Washington coming Wednesday, a quarter-point increase on interest rates doesn't really seem like much of a difference.

But after markets were taken on a wild rideMonday, coming after what had already been the worst weekin more thana year, you have to ask yourself why traders seem so nervous.

What's the effect on me?

And to bring it home to heavily borrowed Canadians: What impact will themere threat of a small rate raisehave on me?

Those dubious of the importance of a tiny increase in interest on things like the housing marketmight alsoask why Bank of Canada governor Tiff Macklem and his counterpart at the U.S. Federal Reserve, Jerome Powell, have been so reluctant to actually pull the trigger and raiserates.

Despite haywire markets, there are many who doubt interest rates will rise tomorrow, when thosecentral bankers both hold monetary policy announcements.

Most commentary seems to suggestPowell will putoff making a move on rates at least untilspring. And those who trade ininterest rate futures,making predictive bets on such things, implythere is only a fiveper cent chance the Fed will alter rates currentlynear zero at tomorrow's meeting.

Macklem may have reasons of his own to delay a move that would make Canadian exports more expensive in our biggest markets. Those same predictive markets that saw a 75 per cent chance of a hike last weekwhen inflation rose to 4.8 per centhave scaled back their outlook to 63 per cent. Expect another re-evaluationafter Monday's wild ride.

But whether or not the central bankers act on Wednesday, or bide their time once again, the question remains:Whyare small changes in interest rates so powerful?

The question applies not just when rates are about to rise, but also when the cost of borrowing is falling,even if being artificially held downby most of the world's central banks.

Lords of easy money?

It also comesas a new booktitled The Lords of Easy Money:How the Federal Reserve broke the American Economyis grabbing lots of attention in the financial press; it'sabout a central banking voice-in-the-wilderness who warned thatthe repeated use of low interest rates to keep stimulating the economy would eventually have dire consequences.

The book profiles Thomas Hoenig, an otherwise straight-laced,conservative president of the Kansas Fed,one of the regionalreserve banks that collectively make upthe U.S. Federal Reserve system.

As the book's author, financial journalist Christopher Leonard, writes, Hoenig worried that endless low rates linked to the Fed's quantitative-easingpolicy would be the opposite of Robin Hood:They wouldgive to the rich in a huge financial bubble, while robbing the poor and middle class.

And he worried that eventually it would all come crashing down.

"He believed that this money would widen the gap between the very rich and everybody else," Leonard writes. "Just as important, this tidalwave of money would encourage every entity on Wall Street to adopt riskier and riskier behaviour and a world of cheap debt and heavy lending, potentially creating exactly the kind of ruinous financial bubble that caused the global financial crisis in the first place."

Reading those sentences this week following the latestmarket chaossends shivers up the spine.

While most central bankers have repeatedly insisted the cause of inflation has not been low rates, but rather shipping bottlenecks and a new consumer urge to spend, many others, including Scotiabank economist Derek Holt, say low rates cannot be ignored as they relate to thiscurrent round of rising prices.

"A contributor to that is the fact that we had generational lowsin interest rates, as monetary policy, partially with the benefit of hindsight, turned out to do a little bit too much in cutting interest rates,"Holttold the CBC following last week's release of the inflation rate.

Mass psychology

Inflation, based on human mass psychology, is not a simple mechanical process. As people who research the actions central bankshave explained in the past, in some ways, setting interest ratesis a way of managing people's beliefs about the value of money.

Despite the fact that the U.S.central banks dumped more than $1trillion into the economy between 2008 and 2010 and have since thenmade it virtually free for banks to borrowthe world continued to believe their money was just as valuable as it had been before.

As University of Alberta economistConstance Smith once told me,a money glut can take years to work through the system, waiting for a trigger.

WATCH | Inflation rate hits 30-year high:

Inflation rate hits 30-year high

3 years ago

Duration 1:59

The rate of inflation has hit its highest point in nearly 30 years, with the cost of groceries seeing the biggest annual increase in a decade. Interest rates are expected to rise soon, but it wont be a quick fix.

Also, the actions of a central bank can haveperverse effects.After a year ofcentral banks insisting inflation is either not coming at all, andthensaying it will be brief and transitory,a move to hike rates to slam on the brakesmay convince consumers and businesses thatinflation is real and something to worry about.

And with so many faulty signals in the past, borrowers and investors can't be sure wheninterest rates will stop rising once they start.

The change from falling rates to rising rates has always been a difficult time. Falling rates make everything easy for investors and consumers. They make bonds and houses rise in value. They tend to make stocks go up. Falling rates make it cheaper to borrow to buy or build new homes. They make it easier for governments to borrow and spend.

Rising rates, if they eventually come, willhave the opposite effect, slowing the entire world economyand making everyone feel poorer in the process.

So that measly quarter-point increase if that's where it stops isnot just on you and your loans andinvestments, but on other people's too, making everything just a little bit harder for everyone all at once.

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