The state of the economy?

Question

Could someone please tell me how does rising interest rates keep a control on inflation.

Answer 1

I often wondered that, since logic dictates that if you put up costs, you put up prices and up goes inflation.

I think it works because borrowing is another form of printing more money, and saving reduces the money in circulation.  High interest rates make borrowing more expensive and saving more lucrative, so people should borrow less and save more.  Or if they borrow more than they can afford, then they go bankrupt and all their money is wiped out and taken out of circulation.

One of the most potent methods to trigger hyper-inflation is to print money.  All currencies have to be supported by something of value, be it gold, property, business assets or future assets. These are finite.  Say one day you have £1 trillion in circulation. Then these assets are worth £1 trillion.  Now you print more money and there is now £2 trillion in circulation.  The assets are the same, so now the money is only worth half the assets it used to be worth, and effectively you have 100% inflation.  If however everyone burns half their banknotes, then the money would be worth twice the assets as before (even if some people who kindly burned their money now find nothing in the pockets to pay for things).  The result is deflation as sellers have to choose whether to lower their prices or not sell their products at all.

Answer 2

Maybe it is because when people have to pay more because of interest rates (like the cost of a mortgage), they can't spend as much elsewhere.  Therefore, there is an effort on the part of businesses to keep the prices down to draw in those consumers.  

However, these days a lot of things effect inflation and I don't think interest rates have as much of an effect as it may have in the past.

Answer 3

It is supposed to reduce a person's ability to be able to buy goods and consequently reduce the level of demand. It is hoped that this will bring down prices. However, with the main reasons for the present inflation related to the global increases in fuel, electricity and gas, increases in prices of essential food and mortgages I do not believe increasing interest rates would have any effect. Unfortunately successive governments have allowed our manufacturing industries to die and we now rely on most of our goods from abroad. Prices are being pushed up in supposedly third world countries and the price of our imports is increasing steadily.

The £ is now in dire straits in global terms and I suspect that as it gradually falls in relation to all other currencies, including the $, inflation will rise further. We are in a bloody awful state and the PM has his head in the sand. I honestly believe we need a coalition of all parties, supported by the best economic advisers available, to try to get us out of the black hole into which we are heading..

Answer 4

Peace and great respect to you my friend.

There is no easy answer to this really..... Rising interest rates does not - in itself - control inflation. Rates need to go down as well as up, and a combination of other closely monitored things need to happen. But basically, in theory anyway, if interest rates go up, the cost of borrowing money will increase and therefore slow down people borrowing money. Also, if interest rates go up, more people are encouraged to save money or invest it. This 'should' help reduce inflation in theory.

BECAUSE.....

If interest rates go up, people have got less to spend, therefore, high street shops are compelled to keep prices down to try to get people to keep buying their stuff - controlling inflation again... IF, prices are kept down and inflation is low, wage bargaining negotiations (people's pay rises) will be kept to a minimum - and therefore keep inflation down so that interest rates may be reduced again.

That seems to have worked well, until recent years. Now, banks and Building Societies have loaned far too much money, the banks have stuck their necks out too far! 'Enter the credit crunch'. So, interest rates may have to rise allot more yet until we are back on track and the banks (bless them) are out of trouble.

Answer 5

Supply and demand, by keeping interest rates at an equal rate current to inflation the demand for loans goes up the main bank of wherever gets the interest back through the government.  The main banks panic over a half percent therefore pushing froward a panic to start panic loans.  Everybody panics banks reap the rewards.  Higher lending drives the economy  everybody prospers especially the banks and private business where as the consumer falters therefore the vicious cycle starts over again.

Answer 6

Interest rates control the amout of money in circulation. When there is alot of money around, good cost more. When money is scarce- goods are cheaper because less buyers with money

In a nutshell