Remember the reasoning behind increasing interest rates reduces inflation, is that it makes it harder for companies to get loans and keep people employed.
Literally, the fed increasing rates means they want to make more people unemployed, because they think inflation is caused by workers having too spending too much of their expendable income.
This is flawed logic in a K shaped economy, or an economy that is under pressure due to a lack of goods because of war and tariffs.
Rasing the interest rates, will not help reduce inflation rates or help the fed meet their 2% goal. This will only hurt workers, and increase federal debt.
There needs to be a plan to address the actual issues that are causing inflation.
Like I explained elsewhere in this thread, the economy running a little too hot is the normal case for raising interest rates to slow down the economy.
When an orangutan is using a ouija board, it seems, to make decisions about the global stability and the economy, this strategy of raising interest rates to deal with fundamentally poor decision-making may not be as effective.
I’m just trying to explain it in simple terms.
I almost never hear economists explain why rasing rates is supposed to lower inflation. Or why it’s the only tool used to try to combat inflation.
Every rate increase is a hope that people lose jobs. And it simply isn’t going to resolve our issues.
Because other options to combat inflation like reducing tariffs, better trade deals and higher taxes are off the table politically in the media.
Can someone explain it like I’m 5 why they’re raising it to curb inflation? I know that if trump wants it, it’s bad for the country, but my brain doesn’t understand why more people buying houses and shit wouldn’t benefit the economy.
More people buying houses makes the price of houses go up faster than the supply of houses. That’s why everyone got pissed about private equity companies buying all the houses. Raising interest rates stops people and companies from buying houses because they can’t finance them, so the price of houses stops going up.
It’s not just houses, that’s just the easy example.
Let me try:
Inflation is traditionally a symptom that the economy is running too well: Businesses are making more money, they are accumulating cash and so are their employees.
Capitalism being as relentlessly exploitative as it is, raises prices on everything that Businesses and employees buy, because they know the businesses and employees can afford it. This is price inflation.
But that can trigger an “arms race” or a self perpetuating sprial of rising prices. In the worst cases of this, there was hyperinflation, where you had to spend all your money each day, because the next day, your cash was practically worthless because prices rose much higher every day.
So to try and keep inflation from getting out of hand, central banks raise interest rates whenever they detect higher prices to raise the cost of borrowing for businesses and people, so they have less cash in hand, and can’t spend recklessly, or be charged recklessly higher prices by capitalists because they just don’t have the extra cash to pay higher prices.
Now all of the above is just if things are normal, and no extraordinary disasters happen such as a pandemic, or an orangutang starting wars that cut off 25% of the world’s oil supply, or suddenly deporting a large part of the blue collar labor force.
These things can lead to instability and unpredictable changes as the economy adjusts, and may take some time to find solutions to reach an equilibrium.
Businesses are making more money, they are accumulating cash and so are their employees.
This seems… dubious. Where is the money coming from? Is it a closed system? My understanding is the government typically is putting money into the system through various mechanisms, much of which is giving money to rich people and their businesses.
Is the problem that the businesses have too much money? Because taxing them seems like a better solution.
so they have less cash in hand, and can’t spend recklessly, or be charged recklessly higher prices by capitalists because they just don’t have the extra cash to pay higher prices.
Get fucked, Sam Altman. Hopefully this finally pops the AI bubble and all the AI CEOs lose everything
or be charged recklessly higher prices by capitalists because they just don’t have the extra cash to pay higher prices
This must be the answer to the question I was asking another commenter. They have to lower prices because people won’t have the cash. I honestly thought people didn’t already have the cash though.
They have to lower prices because people won’t have the cash.
The Fed doesn’t want deflation either, i.e. for prices to decrease rather than increase. Deflation could also set off a bad spiral: why by a toaster today for $30, when you’re confident it will be $25 in a week, or $20 in another week? When people generally expect prices to go down, they refrain from buying things, which forces sellers to offer even lower prices, etc.
So the Fed aims for 2% inflation, where prices will increase each year but only relatively slowly.
They dont. Lots of people are struggling with higher prices. Mostly, the price rises are due to other events, like the war, like the tariffs. Putting the rates up doesn’t help that as much as when the economy is overheating, from going ‘too well’. However, they don’t have many levers to pull and interest rates is one big crude one.
They want more people to be struggling, more people to forego buying things and that makes some people even lose their jobs. They then spend even less. However, it does cause companies to reduce prices to compete, or go bust from lack of sales.
Higher interest rates affect Americans less than in other countries where their mortgages are actually linked to the rate. Americans mortgages tend to be fixed for the term. So when rates go up, people have less money, as well as businesses.
I am not an economist, but if you think of prices in terms of supply and demand, then when there is more demand, prices go up.
When the interest rate is super low, there isn’t much incentive to save money, so consumers spend more, and business take out loans to do more stuff. All of that creates more demand.
When the interest rate is higher, consumers tend to save more money, and businesses are hesitant to take out those loans to expand. All of that decreases demand.
But wouldn’t the volume of spending make up for that with lower interest rates? Meaning, people are already hurting, why should the consumer be the one facing the storm. It seems like businesses raised prices during covid and just kept going. Does the interest rates stop them from raising prices?
There is this funky thing with loaned money that’s a little hard to explain. Loaned money is an economic amplifier. While interest rates adjustments do effect the consumer, the primary target for them is actually banks and businesses.
So when a loan is given it essentially doubles the amount of money in circulation. This is because the lender records the loan as an asset in their books and then the debtor takes that loan and has funds for spending, pushing that money into the economy. So if a bank gives a loan to a big company and that company then gives another big loan using that money to some other third party then the original loan amount triples or something and all of that money is effectively entered into the economic pool.
The average person thinks of this debt in terms of just money for buying physical assets like a car or a house. But that’s not right at the level of the Fed.
See, The Fed sets rates high to help stop things like banks from issues dubious loans or big companies taking on more debt to invest in stocks. I know this isn’t ELI5 but corporate finance is complicated.
The simple answer is that the fed isn’t as concerned with individual loans. Those lending amounts are a drop in the bucket compared to banking and corporate loans. Setting rates higher will effect average people’s loans, but that’s at the end of the domino chain. This is a proven method to help slow inflation because when rates are low, banks and companies are using debt to buy more and buying more drives inflation.
in a healthy economy that’s based on the exchange of goods what you’re thinking might be right, but our economy runs on theoretical values, and on debt. Raising interest rates does a lot of things.
Do I think it will stop businesses from raising prices? no. Should it? yes, based on sound economic theory it should. It won’t, because ‘number must go up’ and most major businesses have stopped practicing consumer based economics. but raising rates will slow the price increases which is really what you want.
edit: This was a bad explanation and I’m sorry. corporate finance is a bunch of bullshit. my actually ELI5 would be that this is to stop BANKS and CORPs from taking loans. not people. Higher interest rates mean that they won’t be as risky with their investing because there would be less reward in immediate access to funds.
Thank you so much, you explained it really well so I could understand. It’s putting a leash on the lenders.
Edit on your edit: No, you did a great job. I get it now.
Even hand picked lap dog Fed Chairman Warsh can’t avoid wave of rising costs from the one man wrecking ball on the global and US economy, food system, etc.
Warsh likely even held the rate rise as low as possible.
I’d be interested to read what interest rate increases other Fed governors were asking for.
If Trump/The Rs/Federalist Society get a majority on the Fed Governing Board, we’re doomed.
