9 ms·

Increasing the interest rate is supposed to fight inflation. I often wonder if that really works. When the risk-free rate rises, doesn't that mean the opposit

Increasing the interest rate is supposed to fight inflation. I often wonder if that really works. When the risk-free rate rises, doesn't that mean the opposite? That _more_ money will be printed? When the government says "You give me $100 and I'll give you back more later" - where is this "more" coming from? Isn't it just more debt that will be paid back with more printed money?

pavlov 4y ago
You can look at Turkey, which has chosen to fight inflation by lowering interest rates. Turkey’s president is an autocrat who can make this kind of decision unilaterally and his economic beliefs run counter to the mainstream, so it makes for a fascinating experiment. He’s been lowering rates for two years, from 18% to 8.5%. The results so far seem to support the economist orthodoxy: inflation in Turkey has ran up to 80% compared to a historical average of about 20% (which was roughly in line with the interest rate when Erdogan started his rate-decrease project.)
- FreeHugs 4y ago
  But was it the lower interest rate that caused the inflation or the printing of money? Over what time did the inflation rate go up from 20% to 80% and by what percentage did the money supply change during that time?
  - pavlov 4y ago
    I'm certainly not any kind of expert on Turkey's economy. I'll just link to graphs that show the effects, someone smarter can debate the cause and effect. The rate cuts in Turkey began in September 2021: https://tradingeconomics.com/turkey/interest-rate https://tradingeconomics.com/turkey/interest-rate The inflation rate soared from 20% to over 80% soon afterwards: https://tradingeconomics.com/turkey/inflation-cpi https://tradingeconomics.com/turkey/inflation-cpi It's now stabilized to "only" 55% because of decreased energy price pressures, apparently. The M2 money supply in Turkish liras is climbing, but not in the same proportion as the rate cuts and inflation: https://tradingeconomics.com/turkey/money-supply-m2 https://tradingeconomics.com/turkey/money-supply-m2 Turkey has also been spending its foreign currency reserves to prop up the lira. They've experimented with extraordinary measures like a government guarantee to protect Turkish account holders against currency depreciation, in an effort to make people keep liras in banks rather than hard currency: https://www.kcl.ac.uk/news/supporting-the-turkish-lira-assessing-the-controversial-experiment-of-the-turkish-central-bank https://www.kcl.ac.uk/news/supporting-the-turkish-lira-asses... So Erdogan's Turkey is an interesting basket case all around — one for future economics textbooks maybe.
    - FreeHugs 4y ago
      The M2 money supply in Turkish liras is climbing, but not in the same proportion as the rate cuts and inflation Not? It looks like the money supply doubled over the last 12 months. Does it really need an expert on Turkey's economy to see a relation between the doubling of an asset and the asset being worth half as much afterwards?
      - pavlov 4y ago
        There are many other factors like the foreign exchange reserves of Turkey and its commercial banks, which have been depleting. Consider a case where a Turkish bank held two billion euros in 2021. They exchange half of it for liras in 2022 and receive N billion liras. A year later and after 80% inflation, they exchange the other half for liras and receive 1.8*N billion liras. That's not the government printing money to fund its spending, yet the money supply is increasing just like you'd see on the graph. Like I wrote in my previous reply, Turkey has a unique program where it guarantees local currency deposits against hard currency exchange rate losses. That's meant to attract deposits and will obviously increase the money supply when locals trade their dollars/euros for liras — but it's not exactly "money printing", rather a completely new layer of risk for the central bank (and the losses may have to be offset by printing money eventually, but importantly that wouldn't show up yet in the graph we're looking at).
        FreeHugs 4y ago
        What does it mean when you say the turkish bank exchanged their Euros for Liras? Where did the Euros go, where did the Liras come from?
        pavlov 4y ago
        The Turkish central bank provides hard currency liquidity. It's absolutely vital for the economy, as import and export businesses in Turkey can't use the lira for most of their operations because foreign companies don't want that kind of emerging market currency risk. The Turkish lira is free floating, so the central bank buys and sells liras at market rates. And seems like they're getting desperate to make sure foreign currency stays in the central bank: https://www.bloomberg.com/news/articles/2023-02-24/turkey-central-bank-warns-lenders-against-sending-dollars-abroad https://www.bloomberg.com/news/articles/2023-02-24/turkey-ce... "The request comes after commercial banks wired a net $2.3 billion to deposit accounts abroad in the first six weeks of the year, one of the people said, asking not to be named because the information is confidential. Hard-currency outflows are hampering efforts to keep the lira stable and inflation in check in the run-up to elections slated for May. "While there are no regulations preventing banks from wiring capital to their correspondent banks abroad, Turkish officials have said that they want free cash kept in the monetary authority’s coffers." So, a Turkish business sells a boatload of plums to Germany and gets paid in euros. The euros are wired from Germany to a Turkish bank. The bank's accounts are held in liras, so the business can't keep the euros directly. Instead the bank deposits the euros with the central bank and gets liras at market rate. The central bank now has more hard currency that Turkey's government might eventually use to pay for things like buying fighter jets (or whatever in the budget that's not domestically produced). The plum business owner isn't very happy about holding liras in his bank account though, because he knows they might be worth 50% less in a year. So he immediately spends the money on things his business needs, paying a bit more than he did last time, just to ensure he can get the products... And that's how local inflation is being fed even by a seemingly positive thing like exporting plums. Government spending wasn't a factor here. But low local interest rate is a factor because lowering the costs of loans enables the plum business owner to spend more liras.
joachimma 4y ago
There are still those that take a loan, they will need to pay the higher interest. As long as there is a balance there will not need to be money printed.
- FreeHugs 4y ago
  One can take a loan from the government?
moondistance 4y ago
It takes many years and higher rates relative to inflation. Based on precedent, we are going to be in this inflationary period for some time.
cowbolt 4y ago
My understanding is that increasing the interest rate causes capital to be more likely to seek low-risk guaranteed returns. The effect of this is to disincentivize investments and economic activity in general, as capital is more likely to be "parked" in risk-free debt, rather than seeking other ways of reaching high yield. The unintuitive aspect of it is how inflation could reach 2% when capital has a guaranteed, risk-free way of generating 5%+ yield. But I suppose that could be explained by examining the growing economic inequality of the past 30+ years.
- FreeHugs 4y ago
  But the "high yield" investments are a zero-sum game. They don't create new money. If you invest in a company and the company is successful, your return is not printed. It comes from the pockets of the companies customers. The risk-free returns on government bonds are risk free because the government never goes bankrupt. Because it simply prints the money it needs.
  - naveen99 4y ago
    When you start a company and a vc gives you a million dollars at a $10 million valuation, 1 million is real, the other 9 just got printed. When you do labor, you print money. When you take out a loan and commit your future labor to paying interest, you are printing money (converting labor to money)
    - FreeHugs 4y ago
      Not by the definition of money I am using when I refer to "the money supply" or the term "printing money". I am referring to sum of money the FED has created.
      - naveen99 4y ago
        There is always two sides to money. The fed pays government workers, the other side is the worker’s labor. Fed buys bonds, the other side is the bond. Fed sells a bond, it destroys the money it receives back. fed buys gold, the other side is the gold. the other side is as much responsible for the money creation as the fed. Fed doesn’t unilaterally create money.
deleted 4y ago
[deleted]
misja111 4y ago
> When the government says "You give me $100 and I'll give you back more later" No it's the other way around. The FED rate is the rate for which the FED will lend you money. The government borrows money by writing out government bonds, which' yield (rate) is determined by the market. Every time the FED lends someone money, it basically prints it. Higher interest rates will cause fewer people to borrow money -> less money is printed -> inflation goes down. At least that's how it works in theory.
- TheOtherHobbes 4y ago
  The theory completes ignores the fact that inflation is driven by two things: external supply shocks and corporate profiteering. There's some catch-up from wage inflation later, but it's a reaction to higher prices not a driver of them. Tinkering with the money supply is like repainting your house when it's on fire. If your house is unstable it's not because it's the wrong colour. It's because the foundations need underpinning and perhaps a redesign.
  - dsfyu404ed 4y ago
    >The theory completes ignores the fact that inflation is driven by two things: external supply shocks and corporate profiteering. Citation please for this supposed "fact". The accepted wisdom is that inflation is driven by the size of the money supply and the velocity of the money.
- flandish 4y ago
  Does this rate not also cause personal mortgages to rise, due to the increase? This effects monthly payments, on already agreed contracts, which makes homeowners struggle, no?
  - jandrewrogers 4y ago
    In the US almost all mortgages are fixed rate, so the monthly payments don't change. The interest rate does not change for the life of the mortgage, often 30 years. Because a mortgage can be refinanced, this causes a downward ratchet on interest rates for mortgages over time. This is one of the ways in which a mortgage is a hedge against inflation and rising costs. There are tens of millions of Americans with a mortgage rate in the 2.5-3.5% range because the mortgages pre-date the current rise in interest rates. What this does impact is the ability of people to move houses, since a new mortgage would be priced to current market conditions.
throw0101b 4y ago
> I often wonder if that really works. Ask Volcker: * https://en.wikipedia.org/wiki/Early_1980s_recession_in_the_United_States https://en.wikipedia.org/wiki/Early_1980s_recession_in_the_U... * https://en.wikipedia.org/wiki/Paul_Volcker#Chairman_of_the_Federal_Reserve https://en.wikipedia.org/wiki/Paul_Volcker#Chairman_of_the_F...
Scarblac 4y ago
No, the debt will be paid back with borrowed money.
- FreeHugs 4y ago
  If it is borrowed from the FED, then it is still paid back with printed money.
naveen99 4y ago
Money is printed every time a commercial bank makes a loan. Money is destroyed when government sells treasuries. If you buy treasuries you aren’t using it to buy goods and services. When bank buys your debt, you spend the money on goods and services.

pavlov 4y ago

You can look at Turkey, which has chosen to fight inflation by lowering interest rates. Turkey’s president is an autocrat who can make this kind of decision unilaterally and his economic beliefs run counter to the mainstream, so it makes for a fascinating experiment. He’s been lowering rates for two years, from 18% to 8.5%. The results so far seem to support the economist orthodoxy: inflation in Turkey has ran up to 80% compared to a historical average of about 20% (which was roughly in line with the interest rate when Erdogan started his rate-decrease project.)

FreeHugs 4y ago
But was it the lower interest rate that caused the inflation or the printing of money? Over what time did the inflation rate go up from 20% to 80% and by what percentage did the money supply change during that time?
- pavlov 4y ago
  I'm certainly not any kind of expert on Turkey's economy. I'll just link to graphs that show the effects, someone smarter can debate the cause and effect. The rate cuts in Turkey began in September 2021: https://tradingeconomics.com/turkey/interest-rate https://tradingeconomics.com/turkey/interest-rate The inflation rate soared from 20% to over 80% soon afterwards: https://tradingeconomics.com/turkey/inflation-cpi https://tradingeconomics.com/turkey/inflation-cpi It's now stabilized to "only" 55% because of decreased energy price pressures, apparently. The M2 money supply in Turkish liras is climbing, but not in the same proportion as the rate cuts and inflation: https://tradingeconomics.com/turkey/money-supply-m2 https://tradingeconomics.com/turkey/money-supply-m2 Turkey has also been spending its foreign currency reserves to prop up the lira. They've experimented with extraordinary measures like a government guarantee to protect Turkish account holders against currency depreciation, in an effort to make people keep liras in banks rather than hard currency: https://www.kcl.ac.uk/news/supporting-the-turkish-lira-assessing-the-controversial-experiment-of-the-turkish-central-bank https://www.kcl.ac.uk/news/supporting-the-turkish-lira-asses... So Erdogan's Turkey is an interesting basket case all around — one for future economics textbooks maybe.
  - FreeHugs 4y ago
    The M2 money supply in Turkish liras is climbing, but not in the same proportion as the rate cuts and inflation Not? It looks like the money supply doubled over the last 12 months. Does it really need an expert on Turkey's economy to see a relation between the doubling of an asset and the asset being worth half as much afterwards?
    - pavlov 4y ago
      There are many other factors like the foreign exchange reserves of Turkey and its commercial banks, which have been depleting. Consider a case where a Turkish bank held two billion euros in 2021. They exchange half of it for liras in 2022 and receive N billion liras. A year later and after 80% inflation, they exchange the other half for liras and receive 1.8*N billion liras. That's not the government printing money to fund its spending, yet the money supply is increasing just like you'd see on the graph. Like I wrote in my previous reply, Turkey has a unique program where it guarantees local currency deposits against hard currency exchange rate losses. That's meant to attract deposits and will obviously increase the money supply when locals trade their dollars/euros for liras — but it's not exactly "money printing", rather a completely new layer of risk for the central bank (and the losses may have to be offset by printing money eventually, but importantly that wouldn't show up yet in the graph we're looking at).
      - FreeHugs 4y ago
        What does it mean when you say the turkish bank exchanged their Euros for Liras? Where did the Euros go, where did the Liras come from?
        pavlov 4y ago
        The Turkish central bank provides hard currency liquidity. It's absolutely vital for the economy, as import and export businesses in Turkey can't use the lira for most of their operations because foreign companies don't want that kind of emerging market currency risk. The Turkish lira is free floating, so the central bank buys and sells liras at market rates. And seems like they're getting desperate to make sure foreign currency stays in the central bank: https://www.bloomberg.com/news/articles/2023-02-24/turkey-central-bank-warns-lenders-against-sending-dollars-abroad https://www.bloomberg.com/news/articles/2023-02-24/turkey-ce... "The request comes after commercial banks wired a net $2.3 billion to deposit accounts abroad in the first six weeks of the year, one of the people said, asking not to be named because the information is confidential. Hard-currency outflows are hampering efforts to keep the lira stable and inflation in check in the run-up to elections slated for May. "While there are no regulations preventing banks from wiring capital to their correspondent banks abroad, Turkish officials have said that they want free cash kept in the monetary authority’s coffers." So, a Turkish business sells a boatload of plums to Germany and gets paid in euros. The euros are wired from Germany to a Turkish bank. The bank's accounts are held in liras, so the business can't keep the euros directly. Instead the bank deposits the euros with the central bank and gets liras at market rate. The central bank now has more hard currency that Turkey's government might eventually use to pay for things like buying fighter jets (or whatever in the budget that's not domestically produced). The plum business owner isn't very happy about holding liras in his bank account though, because he knows they might be worth 50% less in a year. So he immediately spends the money on things his business needs, paying a bit more than he did last time, just to ensure he can get the products... And that's how local inflation is being fed even by a seemingly positive thing like exporting plums. Government spending wasn't a factor here. But low local interest rate is a factor because lowering the costs of loans enables the plum business owner to spend more liras.

joachimma 4y ago

There are still those that take a loan, they will need to pay the higher interest. As long as there is a balance there will not need to be money printed.

FreeHugs 4y ago
One can take a loan from the government?

moondistance 4y ago

It takes many years and higher rates relative to inflation. Based on precedent, we are going to be in this inflationary period for some time.

cowbolt 4y ago

My understanding is that increasing the interest rate causes capital to be more likely to seek low-risk guaranteed returns. The effect of this is to disincentivize investments and economic activity in general, as capital is more likely to be "parked" in risk-free debt, rather than seeking other ways of reaching high yield. The unintuitive aspect of it is how inflation could reach 2% when capital has a guaranteed, risk-free way of generating 5%+ yield. But I suppose that could be explained by examining the growing economic inequality of the past 30+ years.

FreeHugs 4y ago
But the "high yield" investments are a zero-sum game. They don't create new money. If you invest in a company and the company is successful, your return is not printed. It comes from the pockets of the companies customers. The risk-free returns on government bonds are risk free because the government never goes bankrupt. Because it simply prints the money it needs.
- naveen99 4y ago
  When you start a company and a vc gives you a million dollars at a $10 million valuation, 1 million is real, the other 9 just got printed. When you do labor, you print money. When you take out a loan and commit your future labor to paying interest, you are printing money (converting labor to money)
  - FreeHugs 4y ago
    Not by the definition of money I am using when I refer to "the money supply" or the term "printing money". I am referring to sum of money the FED has created.
    - naveen99 4y ago
      There is always two sides to money. The fed pays government workers, the other side is the worker’s labor. Fed buys bonds, the other side is the bond. Fed sells a bond, it destroys the money it receives back. fed buys gold, the other side is the gold. the other side is as much responsible for the money creation as the fed. Fed doesn’t unilaterally create money.

deleted 4y ago

[deleted]

misja111 4y ago

> When the government says "You give me $100 and I'll give you back more later" No it's the other way around. The FED rate is the rate for which the FED will lend you money. The government borrows money by writing out government bonds, which' yield (rate) is determined by the market. Every time the FED lends someone money, it basically prints it. Higher interest rates will cause fewer people to borrow money -> less money is printed -> inflation goes down. At least that's how it works in theory.

TheOtherHobbes 4y ago
The theory completes ignores the fact that inflation is driven by two things: external supply shocks and corporate profiteering. There's some catch-up from wage inflation later, but it's a reaction to higher prices not a driver of them. Tinkering with the money supply is like repainting your house when it's on fire. If your house is unstable it's not because it's the wrong colour. It's because the foundations need underpinning and perhaps a redesign.
- dsfyu404ed 4y ago
  >The theory completes ignores the fact that inflation is driven by two things: external supply shocks and corporate profiteering. Citation please for this supposed "fact". The accepted wisdom is that inflation is driven by the size of the money supply and the velocity of the money.
flandish 4y ago
Does this rate not also cause personal mortgages to rise, due to the increase? This effects monthly payments, on already agreed contracts, which makes homeowners struggle, no?
- jandrewrogers 4y ago
  In the US almost all mortgages are fixed rate, so the monthly payments don't change. The interest rate does not change for the life of the mortgage, often 30 years. Because a mortgage can be refinanced, this causes a downward ratchet on interest rates for mortgages over time. This is one of the ways in which a mortgage is a hedge against inflation and rising costs. There are tens of millions of Americans with a mortgage rate in the 2.5-3.5% range because the mortgages pre-date the current rise in interest rates. What this does impact is the ability of people to move houses, since a new mortgage would be priced to current market conditions.

throw0101b 4y ago

> I often wonder if that really works. Ask Volcker: * https://en.wikipedia.org/wiki/Early_1980s_recession_in_the_United_States https://en.wikipedia.org/wiki/Early_1980s_recession_in_the_U... * https://en.wikipedia.org/wiki/Paul_Volcker#Chairman_of_the_Federal_Reserve https://en.wikipedia.org/wiki/Paul_Volcker#Chairman_of_the_F...

Scarblac 4y ago

No, the debt will be paid back with borrowed money.

FreeHugs 4y ago
If it is borrowed from the FED, then it is still paid back with printed money.

naveen99 4y ago

Money is printed every time a commercial bank makes a loan. Money is destroyed when government sells treasuries. If you buy treasuries you aren’t using it to buy goods and services. When bank buys your debt, you spend the money on goods and services.