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There's a lot about economics I don't understand. Could someone explain (or point me to a resource on) how raising rates helps to control / reduce inflation?

voisin 5y ago
Raising rates means projects that would inevitably be paid for in part by debt would be more expensive than when rates were lower. So projects at the margin suddenly aren’t profitable and are cancelled. Less demand at the margins means less pricing pressure upwards, so less inflation.
AtlasBarfed 5y ago
Demand is currently greater than supply in so many ways (see: computer chips). A lot of inflation is because the suppliers can "gouge" customers. It's why the car makers are really profitable but selling way less: they only sell the expensive versions of what they can make, and then there is gouging on top of that by the dealers for example. But if you raise rates, then consumers and business buyers can't access as much money on cheap credit, so they buy less / delay / make do with what they have. Demand for goods drops, so the difference between demand and supply evens out. But slowing the exchange of goods and services means GDP slows ... is another way of saying "recession". Western economies have been floating on zero/negative credit for so long to keep their economies "stable" aka propped up. We'll see what happens... If you don't understand why the FED changing interest rates has such cascading changes, it's because all the banks that you would get a loan from peg their interest rates to the FED's (plus a markup), because the FED supplies money to banks when they need at by loaning it to them ... at the federal rate.
scottiebarnes 5y ago
- Interest rate is the cost of borrowing money; if the cost is high, people/businesses generally borrow less - Borrowing money involves the creation of new money (fractional reserve banking); when you get a loan from a bank, they only have to have a certain portion of that backed by actual cash, the rest is created out of thin air. So you get your loan and spend it immediately. When enough people are borrowing, there is more money flying around; an economy can only produce so many "things" at once, so we have to compete over our purchases. This demand, fueled by borrowing, pushes prices up.
cameldrv 5y ago
The simplest, most direct explanation is that debt markets are an auction. Low bond prices are equivalent to high interest rates. If the Fed wants to lower interest rates, it buys bonds using money it creates, pushing up the price of the bonds, and effectively lowering interest rates. When new money is created, it dilutes the value of existing money, causing inflation. If the Fed wants to lower inflation, it needs to create less money. To do that it needs to buy fewer bonds. Less bond buying causes bond prices to go down, and therefore interest rates to go up. Now, the real world is a lot more complicated than this, and it depends on what exactly is happening with all of that extra money, but this is the first order explanation.
imtringued 5y ago
In theory there is no evidence for that in almost any mathematical model. Since paying off goverment debt is almost mathematically impossible goverments are forced to borrow even if the interest is high leading to more inflation over the long term. In practice people are scared into borrowing less and pay off their existing debts.

voisin 5y ago

Raising rates means projects that would inevitably be paid for in part by debt would be more expensive than when rates were lower. So projects at the margin suddenly aren’t profitable and are cancelled. Less demand at the margins means less pricing pressure upwards, so less inflation.

AtlasBarfed 5y ago

Demand is currently greater than supply in so many ways (see: computer chips). A lot of inflation is because the suppliers can "gouge" customers. It's why the car makers are really profitable but selling way less: they only sell the expensive versions of what they can make, and then there is gouging on top of that by the dealers for example. But if you raise rates, then consumers and business buyers can't access as much money on cheap credit, so they buy less / delay / make do with what they have. Demand for goods drops, so the difference between demand and supply evens out. But slowing the exchange of goods and services means GDP slows ... is another way of saying "recession". Western economies have been floating on zero/negative credit for so long to keep their economies "stable" aka propped up. We'll see what happens... If you don't understand why the FED changing interest rates has such cascading changes, it's because all the banks that you would get a loan from peg their interest rates to the FED's (plus a markup), because the FED supplies money to banks when they need at by loaning it to them ... at the federal rate.

scottiebarnes 5y ago

- Interest rate is the cost of borrowing money; if the cost is high, people/businesses generally borrow less - Borrowing money involves the creation of new money (fractional reserve banking); when you get a loan from a bank, they only have to have a certain portion of that backed by actual cash, the rest is created out of thin air. So you get your loan and spend it immediately. When enough people are borrowing, there is more money flying around; an economy can only produce so many "things" at once, so we have to compete over our purchases. This demand, fueled by borrowing, pushes prices up.

cameldrv 5y ago

The simplest, most direct explanation is that debt markets are an auction. Low bond prices are equivalent to high interest rates. If the Fed wants to lower interest rates, it buys bonds using money it creates, pushing up the price of the bonds, and effectively lowering interest rates. When new money is created, it dilutes the value of existing money, causing inflation. If the Fed wants to lower inflation, it needs to create less money. To do that it needs to buy fewer bonds. Less bond buying causes bond prices to go down, and therefore interest rates to go up. Now, the real world is a lot more complicated than this, and it depends on what exactly is happening with all of that extra money, but this is the first order explanation.

imtringued 5y ago

In theory there is no evidence for that in almost any mathematical model. Since paying off goverment debt is almost mathematically impossible goverments are forced to borrow even if the interest is high leading to more inflation over the long term. In practice people are scared into borrowing less and pay off their existing debts.