Question How does raising interest rates control inflation?

[Neal]

I saw a headline this morning that the fed needs to rapidly and aggressively raise interest rates - now! I don't get it. This seems like it would kill the economy and stop people from buying. Is this intentional to stop consumers from purchasing? How does raising interest rates help matters other than banks/credit cards or people lending money to make more money?

 

[Neemer]

Yes. The idea is to put a damper on demand and slow the economy.

 

[Scooterfan]

Neal, you hit the nail one the head. That's the concept anyway. Remember the Carter administration days...prime lending rate hit 19%. The problems is, this action often leads to a recession (albeit intentional). Nothing like higher interest rates to curtail the real estate market and high priced items (RV's ???). Insiders believe the internals are much worse than disclosed and we are one click away from a corrective recession. A new administration could turn this around quickly I believe (IMHO), but we are probably out of time. But hey, what do I know What I see as a greater problem is that "Globalization" efforts to date have "hog tied" us to some externals we have little control over. Now that could get ugly. I say, fill 'er up, hit the road, and enjoy GOD's Creation. Blessings

Bachmann: Biden to 'Transfer U.S. Sovereign Authority' to World Health Organization, 'Create a Global Platform for Global Government' - American Faith

"These amendments would transfer our healthcare decision making out of U.S. hands into the hands of the Director General of the WHO," says Bachman.

americanfaith.com

 

[Lab00Rat]

Money is cheap, so the velocity of money in the economy is speeding up resulting in inflation. There was no restraint to borrowing from the Fed to expand the economy; however, the expansion has surpassed supply. When production cannot keep up with the money supply, inflation happens. Too many dollars chasing too few goods.
Raising interest rates is one step to recover dollars and slow the velocity of money. Unfortunately, we have a bigger issue in the supply chain that prevents the available dollars from being spent and soaked out of the economy.
Regan implemented a supply side economy in the 80s to reduce inflation. Ramp up all production and reduce taxes, fees, and regulations on the supply side to speed up good. This resulted in the reduction in the velocity of money with the increased interest rates - really high until the inflation was controlled.

We do not have Regan, and we have no supply side support.
The economy is in for a really rough ride because you are correct. Raising the interest rates will slow the economy, but there is no supply to absorb the extra dollars in circulation. The cost of goods will increase and not deflate after the velocity is reduced. Your retirement just got smacked.

 

[AbdRahim]

Print and hand out more money someone said. Uh oh, there is too much money. Now we have to slow the train we pushed over the hill. It is often better to let the economy work and stop trying to fix stuff, which results in other stuff that later has to be fixed. Humans. I will never understand them!

 

[Pablo]

Money is cheap, so the velocity of money in the economy is speeding up resulting in inflation. There was no restraint to borrowing from the Fed to expand the economy; however, the expansion has surpassed supply. When production cannot keep up with the money supply, inflation happens. Too many dollars chasing too few goods.
Raising interest rates is one step to recover dollars and slow the velocity of money. Unfortunately, we have a bigger issue in the supply chain that prevents the available dollars from being spent and soaked out of the economy.
Regan implemented a supply side economy in the 80s to reduce inflation. Ramp up all production and reduce taxes, fees, and regulations on the supply side to speed up good. This resulted in the reduction in the velocity of money with the increased interest rates - really high until the inflation was controlled.

We do not have Regan, and we have no supply side support.
The economy is in for a really rough ride because you are correct. Raising the interest rates will slow the economy, but there is no supply to absorb the extra dollars in circulation. The cost of goods will increase and not deflate after the velocity is reduced. Your retirement just got smacked.

This is the correct explanation. You understand how this works 100%.
They increase the interest rate to slow down the money circulation to cool down demand.

 

[Jim]

This is the correct explanation. You understand how this works 100%.
They increase the interest rate to slow down the money circulation to cool down demand.

Quick question if you don't mind, @Pablo, but what's wrong with high demand? That seems to me like a good thing. No?

 

[Pablo]

Quick question if you don't mind, @Pablo, but what's wrong with high demand? That seems to me like a good thing. No?

Nothing is wrong with high demand, but you have to be able to satisfy the market.
Read the first paragraph of the original post
"When production cannot keep up with the money supply, inflation happens. Too many dollars chasing too few goods"

 

[Neal]

I'll state the obvious that I don't think any company that can't keep up with the demand wants this problem solved by the government taking away their demand. Companies obviously would prefer to grow, hire, and produce, to meet demands instead of the opposite, layoff employees when demand disappears.

It's going to be interesting to watch Newmar this year. They raised their prices to the point it's laughable and then this happens. We'll see how this year plays out.

 

[redbaron]

@Neal

The point is we need poverty in order to have wealth, but we don't need a large pool of poverty.

We have to reset the game of financial life so that some players start over, others hold steady, and a few jump up to the next level.

Runaway pricing on everyday items causes the weak to fail, but also causes those that are normally steady to fail.

The slowing of the market is how new failure is introduced quickly to protect the masses.

Business and individuals strapped with high debt and low cash reserves will suffer, while those with little debt and high reserves will flourish.

Take out the unrealistic demand, and we return the "normal" life for a few more years.

Rinse and repeat.

 

[Lab00Rat]

@Neal

The point is we need poverty in order to have wealth, but we don't need a large pool of poverty.

We have to reset the game of financial life so that some players start over, others hold steady, and a few jump up to the next level.

Runaway pricing on everyday items causes the weak to fail, but also causes those that are normally steady to fail.

The slowing of the market is how new failure is introduced quickly to protect the masses.

Business and individuals strapped with high debt and low cash reserves will suffer, while those with little debt and high reserves will flourish.

Take out the unrealistic demand, and we return the "normal" life for a few more years.

Rinse and repeat.

Yes, and no.

Resetting the game of financial life is a banking term called Rowing the Economy. It's pure bunk to inflict intentional stress to cause cyclic distress. It's a fact of our lives, yes; however, it's complete crap in practice because it's designed to proportionally favor banks or the wealthy at the expense of the working. Very few make the jump up in class, and most are knocked down in class. This cycle will unfortunately affect standard of living for 95% of everyone. Even if you have no debt with high reserve cash, the best situation, you will be affected. What the comfortable cash reserve level will be is unknown at this time, but the return to "normal" will not be any time soon.

Be mindful of your financial institution. Your large cash reserve is at the mercy of poor decisions from others. Savings are not saving these days as 20 years ago. Your savings are an "investment" in the bank holding your moneys. Being an investment, the bank can leverage your funds for their activities. It's not always good activities that have sound financial backing. Downturns like this one can ruin banks. Lehman Brothers was the 2008. Now, every institution can be a Lehman.

The financial tools to recover from a downturn were used and exhausted by the Fed. There will be no way to use the same tools to recover from this cycle. New tools will be needed, but likely will not be invented until way too late to help. I'm all for a really old tool that has worked well in the past. Lincoln and JFK both used it to end inflation and restore purchasing power of the dollar. Unfortunately, it's taboo to suggest as both were "removed" from office after implementing the program.

The removal of "unrealistic" demand is a function of inflation. Inflation is the direct response to demand and is proportional to cash availability. Even if you have a large pool of cash at hand and no debt, prices will continue to rise until the all cash reserve is reduced to production capacity. The devil in this detail is that the US doesn't produce very much. Therefore, the cost of goods will be balanced globally and not nationally. Western society is in for a really rough ride. Strong dollar is the best we can hope for because that will allow the US better purchase power in the global demand vs other weak currencies competing for the same products. This cycle downturn will be intensified by sovereign debt purchasing product that has no limit or reserve. Your pile of cash means nothing to the power of the printing press. There are a few ways to protect against this type of inflation, but it's a personal choice. I won't elaborate because I'm not an advisor.

(Un)fortunately, there has been a race to the bottom with printing for most currencies. We are not the only ones to print into inflation, and it's been steady for a decade. This apples to both purchase and sale of goods made in the US! You are competing on a global scale for products made here because another nation can buy what we produce if they are willing to spend more to acquire it. Gas and oil export are a good/easy trail to follow. Farm goods like pork is another to look into. Bottom line, ALL goods produce are open to global trade and you are buying at global demand prices. Again, a strong dollar helps keep these needed goods in the US because our purchase power is greater than a weaker currency. Cold prediction for demand of staple goods will have nations printing sovereign debt to buy food goods. Therefore, food prices will skyrocket as nation states buy at any cost to protect from starvation. Unfortunately, it's currency suicide for debt leveraged like this, but desperate times will have desperate measures.

If this becomes a depression, all bets are off. Use Japan as a case study for modern version of a decade in stagflation (following a depression). For a slightly older case study, look to Cuba and their coping mechanisms for financial hardship post collapse. I hope it's not as bad as either, but we live in a society where we are not the same. Your neighbor could be struggling like Cuba, and the major cities (or you) mirror Japan stagflation.

Just my opinions...

 

[Scooterfan]

If this becomes a depression, all bets are off

Hadn't really thought about this possibility. I understand this has a long way to go, and would agree a recession is a distinct possibility, but didn't factor in a depression. That would be new territory to almost all (USA) citizens.
It's sad this administration is leading us down this path, and I pray for a (huge) change in leadership (soon), but until then perhaps I'll raise some chickens and maybe a pig Blessings

 

[RangeMaggotBob]

TRYING not to get political, BUT- not saying who, because it's obvious- they're taking us right down the drain.

 

[Lab00Rat]

TRYING not to get political, BUT- not saying who, because it's obvious- they're taking us right down the drain.

Both parties are guilty of printing, but the Federal Reserve is the root of all evil we have had for the past 100 years. I square all the blame for those who are responsible for managing to money supply, but surrendered it to private central banks. The Federal Reserve got us into this mess by over printing our currency. Congress let them do it.