Higher interest rates lower inflation by tossing people out of work so that they can’t afford to buy stuff. Things can get worse.
Higher interest rates lower inflation by tossing people out of work so that they can’t afford to buy stuff. Things can get worse.
I’m no economist but here’s my understanding: When interest rates go up, borrowing money becomes more expensive. This leads to less borrowing, which reduces the money supply. (When you borrow money from the bank, the bank just creates the money. They’re mostly not giving you existing money.) By reducing the money supply, inflation may be reduced.
Higher interest rate -> decreased borrowing -> decreased money supply -> decreased demand/ability to purchase/inflation/ decreased price increase
Also, higher interest rates flow through to those with existing loans and also if/when they refinance. From businesses to credit cards, payday loans, probably even pawn shops. Even the government itself.
If you have to pay more on your loan, you have less to spend on everything else.
So, interest rate rises also put a handbrake on spending, which slows down the economy, and attempts to slow down inflation too. In theory.
Stay tuned next week where we learn about how once you get inflation reducing, it usually means a rise in unemployment!
The good times never end
the interest rate has been refered to as the price of money.
Interest rates go up which results in increased revenue (and money) for the bank, which doesn’t have value backing it. In essence it increases the amount of dollars in the economy, lowering the value of the existing dollars within the economy.
People don’t just stop borrowing money when interest rates go up, especially when the economy is so bad people can’t afford to live on their pay.
Keep in mind what interest represents to the bank.
You’d think, intuitively, that it works this way but you’re missing the key concept: fractional reserve banking.
The bank doesn’t take $10 from a savings account, loan it out, and then get something like $11 back, thus creating $1 from somewhere.
What the bank actually does is takes $10 from a savings account then magically creates $90 and loans out $100, because somehow they’re allowed to do this. This is fractional reserve banking. They only actually have a fraction of what they loan out.
Banks create money by giving out loans. When loans are more expensive, fewer are given, less loan money is created and the amount of total money in circulation (and inflation) are reduced.
Or at least that’s what I’ve read.
This goes against all the hard data we’ve got from the past 80 years of the Fed independently managing interest rates, but yeah dawg, I’m sure your vibes-based economic theory has finally cracked the code that Shadow Emperor JPow has been hiding from us, and all that rampant inflation from 0% interest rates is fake news.
You’re making a lot of assumptions about how I think here dude. Also i never said that was the only thing that affects inflation.
There are a lot of factors that push and pull. I know there’s a lot of info out there that contradicts what I said but I also know there is a lot of incentive for us to believe that banks increasing rates naturally lowers supply of money in an economy, so of course you’ll find a ton of articles stating that as fact – needless to say I am skeptical.
I don’t know if it’s completely true, just like how the invisible hand of the capitalist economy is assumed to allocate resources effectively, but we know that in practice it does not, because people don’t just choose to stop purchasing things they need when they get expensive.
So my thoughts are this: how much of this theory is based on an assumption of human nature that’s more optimistic than in practice? Because a LOT of our economic theory operates this way.