Eight times a year, a small committee in Ottawa — and another in Washington — sets the price of money itself. Here is what they actually do, and how one number reaches your mortgage, your job, and your portfolio.
A bank for banks
The Bank of Canada and the US Federal Reserve do not serve people; they serve banks and governments. Their legal mandate is to keep inflation low and stable (Canada targets 2%) and, in the Fed's case, also to support maximum employment. Everything they do flows from those goals.
Their main tool is the policy rate — in Canada, the overnight rate: the interest banks charge each other for one-day loans. It sounds obscure, but it is the base price of money. Every other rate in the country — prime, mortgages, car loans, savings accounts, business credit — is built on top of it.
The thermostat
Think of the economy as a house and the policy rate as a thermostat working in reverse. When the economy runs hot — everyone spending, prices rising too fast — the central bank raises rates. Borrowing gets expensive, households and companies cut back, and inflation cools. When the economy is cold — layoffs, falling spending — it cuts rates to make borrowing cheap and coax money back out.
The catch is the lag. A rate change takes roughly 18 to 24 months to fully work through the economy, so central bankers are always steering by where they think the economy will be, not where it is. That is why they can overshoot in both directions — hiking into a slowdown, or cutting into a boom.
When rates aren't enough: QE and QT
In 2008 and again in 2020, rates hit zero and economies still needed help. Central banks turned to quantitative easing (QE): creating new money to buy government bonds by the hundreds of billions, pushing long-term rates down and flooding markets with cash. The reverse — letting those bonds mature or selling them, draining money back out — is quantitative tightening (QT).
QE is controversial. It arguably prevented depressions, but it also inflated the price of assets — stocks, houses — which benefits people who already own them. When you hear that 'the Fed is expanding its balance sheet', this is what's being described.
How one decision reaches your kitchen table
Follow a single Bank of Canada hike of 0.25%: within hours, the big banks raise prime. Variable mortgages and lines of credit reprice within days. Bond yields shift, so new fixed mortgages cost more within weeks. Businesses shelve expansion plans, hiring slows over months, and with less money chasing goods, inflation eases over a year or two. The stock market, trying to price all of this instantly, often moves within minutes of the announcement.
This is why markets hang on every word a central banker says. The decisions are scheduled (eight 'fixed announcement dates' a year in Canada), the statements are parsed like scripture, and even a changed adjective can move billions.
The takeaways
- Central banks set the base price of money to keep inflation near 2%.
- Raising rates cools the economy; cutting heats it — with an 18–24 month lag.
- QE creates money to buy bonds when rates hit zero; QT drains it back out.
- One rate decision reaches mortgages in days, jobs in months, inflation in years.
Words used here — look them up
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