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Explain interest rates and inflation
Posted on 6/8/22 at 1:09 pm
Posted on 6/8/22 at 1:09 pm
Trying to understand how this works.
If you raise interest rates it should help reduce inflation because people borrow less money and therefore there's less cash in the market today.
However, raising interest rates should also increase the cost of doing business which should cause businesses to raise their prices to pass the cost on to consumers, right? So that would imply that raising rates increases inflation. The increased cost of doing business also slows company growth and pushes towards a recession.
Additionally increased interest rates should incentivize people to save more cash as returns would be higher which could also push towards a recession due to less consumer spending, but the banks pass on such low savings rates that it probably makes very little difference. I could actually see an argument that consumers could increase spending to buy before inflation gets worse, which would only increase inflation: Borrow now and pay back later with money that has less purchasing power.
So does raising interest rates actually help inflation?
If you raise interest rates it should help reduce inflation because people borrow less money and therefore there's less cash in the market today.
However, raising interest rates should also increase the cost of doing business which should cause businesses to raise their prices to pass the cost on to consumers, right? So that would imply that raising rates increases inflation. The increased cost of doing business also slows company growth and pushes towards a recession.
Additionally increased interest rates should incentivize people to save more cash as returns would be higher which could also push towards a recession due to less consumer spending, but the banks pass on such low savings rates that it probably makes very little difference. I could actually see an argument that consumers could increase spending to buy before inflation gets worse, which would only increase inflation: Borrow now and pay back later with money that has less purchasing power.
So does raising interest rates actually help inflation?
4
Posted on 6/8/22 at 2:09 pm to Yeti_Chaser
Kill demand. Usually causes recession.
The whole soft landing from the biggest money printing bonanza is just ludicrous. Not to mention, please point to one time in history the fed has been “right”. I use quotes, because they are obviously intelligent people who know what is going to happen yet typically publicity predict something contrary.
The whole soft landing from the biggest money printing bonanza is just ludicrous. Not to mention, please point to one time in history the fed has been “right”. I use quotes, because they are obviously intelligent people who know what is going to happen yet typically publicity predict something contrary.
Posted on 6/8/22 at 2:13 pm to Yeti_Chaser
May I recommend Understanding Money Mechanics by Robert Murphy as an introduction?
Posted on 6/8/22 at 2:29 pm to Yeti_Chaser
quote:Not necessarily - it increases the cost of borrowing and growth. In theory it doesn't increase the cost of doing business unless a company is funding their business with debt and not revenue. That is why we see no revenue growth companies fizzle out during rate increase cycles.
However, raising interest rates should also increase the cost of doing business which should cause businesses to raise their prices to pass the cost on to consumers, right?
Posted on 6/8/22 at 3:50 pm to Yeti_Chaser
Inflation is an imbalance of supply and demand. Aggregate demand exceeds aggregate supply. Too much money chases too few goods.
So how might raising interest rates help?
The higher cost of money reduces your purchasing power. The Fed is effectively making you buy less. And that should bring down inflation.
For example, mortgage rates are rising making it more costly to buy a house. That may not lower inflation in home prices immediately because the supply of materials and available workers is so tight and demand is so high.
The Fed can’t do much about those shortages.
But the higher interest rates are likely to shift the relationship of supply and demand, lowering the rate of inflation.
So how might raising interest rates help?
The higher cost of money reduces your purchasing power. The Fed is effectively making you buy less. And that should bring down inflation.
For example, mortgage rates are rising making it more costly to buy a house. That may not lower inflation in home prices immediately because the supply of materials and available workers is so tight and demand is so high.
The Fed can’t do much about those shortages.
But the higher interest rates are likely to shift the relationship of supply and demand, lowering the rate of inflation.
Posted on 6/8/22 at 6:54 pm to Turf Taint
quote:
The higher cost of money reduces your purchasing power. The Fed is effectively making you buy less. And that should bring down inflation.
So do interest rates have to match inflation rates to get there? I'd still borrow under a 5.5% mortgage rate and pay it back later with money that has less purchasing power when inflation is at 16%
Posted on 6/9/22 at 3:02 pm to Yeti_Chaser
Short answer is no. The Fed's interest rate moves do not have a simple 1:1 transmission into the the markets.
Why?
Inflation is caused when aggregate demand exceeds aggregate supply. The Fed uses multiple tools to reduce demand (purchasing power) to mitigate inflation.
How?
1. The Fed uses the federal funds rate (their cost of lending to other banks)
2. Control of the money supply
Federal funds rates:
Interest rates affect a broader scope of the market economy than just mortgages. For example, banks that borrow from Fed have higher cost of capital, that ultimately transmits across commercial, savings & loans, investments...not just mortgages. The interest rates penetrates the market economy across value chains, not just end consumers (ie, businesses that borrow from banks to make goods and services for their customers that transmits to customers' customers and/or consumers).
Control of money supply:
The Fed also uses its control of money supply to intervene in inflation. For example, it expires (is not longer buying or putting money into banks) securities to reduce commercial banks reserves. The money supply in circulation is reduced as banks do not have this money to make loans to consumers and businesses. Less money in circulation negatively impacts aggregate demand.
Long winded to say, no.
Why?
Inflation is caused when aggregate demand exceeds aggregate supply. The Fed uses multiple tools to reduce demand (purchasing power) to mitigate inflation.
How?
1. The Fed uses the federal funds rate (their cost of lending to other banks)
2. Control of the money supply
Federal funds rates:
Interest rates affect a broader scope of the market economy than just mortgages. For example, banks that borrow from Fed have higher cost of capital, that ultimately transmits across commercial, savings & loans, investments...not just mortgages. The interest rates penetrates the market economy across value chains, not just end consumers (ie, businesses that borrow from banks to make goods and services for their customers that transmits to customers' customers and/or consumers).
Control of money supply:
The Fed also uses its control of money supply to intervene in inflation. For example, it expires (is not longer buying or putting money into banks) securities to reduce commercial banks reserves. The money supply in circulation is reduced as banks do not have this money to make loans to consumers and businesses. Less money in circulation negatively impacts aggregate demand.
Long winded to say, no.
Posted on 6/9/22 at 6:48 pm to Turf Taint
quote:
The interest rates penetrates the market economy across value chains, not just end consumers (ie, businesses that borrow from banks to make goods and services for their customers that transmits to customers' customers and/or consumers).
This would slow company growth which moves us towards a recession but should also increase the cost of doing business which I would think companies would pass on to the consumer in the form of higher prices, making inflation worse. Though as another poster pointed out above it should only affect companies funding their business with debt rather than revenue (which seems like another way small businesses will get eaten up by the bigger guys).
quote:
2. Control of the money supply
Isn't this part of what got us here? This seems to me like the logical solution, but maybe I'm missing something. As long as they're pumping up the money supply won't interest rates have to match the inflation rate to keep up?
Posted on 6/9/22 at 7:05 pm to Yeti_Chaser
quote:
This would slow company growth which moves us towards a recession
Fed's job is a balancing act, like the flying Willenda's at a circus
quote:
companies would pass on to the consumer in the form of higher prices, making inflation worse
You assume consumers will be willing / able to pay that price. Don't. Look up price elasticity in economics. Demand destruction is inevitable, particularly in commodity goods.
quote:
funding their business with debt rather than revenue
Businesses without debt are not the exception. Debt at rising interest rates is still cheaper than equity.
quote:
As long as they're pumping up the money supply
Yes (see Allan Greenspan for what not to do), but that is not what Fed is doing. Fed is now reducing the money supply to counter inflation
Posted on 6/9/22 at 7:07 pm to Turf Taint
quote:
Businesses without debt are not the exception
I mean, ARE the exception
Long day
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