Lessons on Inflation and Rates from 21.5% Mortgages and 19.5% Canada Savings Bonds of 1981

In 1981, the safest investment imaginable returned 19.5%.

Now discontinued, Canada Savings Bonds have worked for decades as a reliable way to save money safely. But the CSBs have never been better than in 1981, a year when inflation out of control reached 12.5%.

Inflation is 8.1% today in Canada and reached 9.1% last month in the United States. But the best rate you can get on safe savings is 3% for a high rate savings account and around 4-5% on a guaranteed investment certificate.

There is a strong argument against saving today as your return after inflation is negative. Pay no attention to it. By saving – or more accurately, not spending – we are helping to reduce inflation and the need for the kind of shock interest rate hikes we saw last week.

When the Bank of Canada raised its key rate by one percentage point to 2.5%, it was the largest increase in this benchmark index since 1998. But it was the early 1980s that seemed most relevant in today’s world characterized by high inflation and soaring rates. Consider this period as an example of what happens if we don’t get inflation under control quickly.

According to Mike Moffatt, an economist and assistant professor at the Ivey Business School at the University of Western Ontario, the early 1980s marked the peak of a sharp rise in inflation in the 1970s. era had to react with massive force, which meant raising their benchmark rates into the economic stratosphere.

The Bank of Canada’s policy rate reached 21% in 1981, and the prime rate used by major banks for elite borrowers peaked at 22.75%. The current prime rate is 4.7%.

Recent rate hikes by the Bank of Canada are an attempt to contain inflation before it embeds itself in the economy as it did in the 1970s, Professor Moffatt said.

“Inflation is kind of priced in if you expect prices to go up 7 or 8% a year,” he said. “You’re not going to save money – you’re going to go out and buy things right away. Because the longer you wait, the higher the prices will go.

The Bank of Canada has been criticized for too long for viewing inflation as temporary and thus delaying a return to more normal interest rates after pandemic lows. But last week’s oversized overnight rate hike shows a commitment to aggressively counter inflation.

Professor Moffatt said that a large part of our inflation problem is caused by high energy and food prices, which are linked to the war in Ukraine and supply chain problems linked to the pandemic. But he also sees signs of an inflationary mindset in the population.

“There seems to be this kind of belief that inflation is here to stay and I think that’s causing people to rethink their behavior – asking for pay raises and things like that,” he said.

It’s up to the Bank of Canada, not you, to create the conditions where people don’t have to ask for a big raise to keep up with the cost of living. But the world of 1981 reminds us of what happens when inflation guides our economic behavior.

One-year mortgage rates hit 21.25% in the summer of 1981, according to Bank of Canada records. In addition to this jumbo rate on CSBs, a maximum yield of 18.8% was available on five-year Government of Canada bonds.

The result of such high rates has been a decline in inflation and, consequently, in rates themselves. Mark here the lesson for savers in a time of high inflation. The higher the bond and GIC rates, the more reward there is for buying them and locking them in for as long as you can. The moment of opportunity may not last, however.

“I think there will be a peak for the rates, not a plateau,” Professor Moffatt said. “We will reach a certain level where the risk of inflation will go down, and then interest rates can kind of come back down slowly. Anyone who locks in and buys a five- or ten-year bond at the top will do very well.

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