It seems we are in a similar situation today (though not exactly the same as unemployment is generally low). At some point, it seems fairly obvious that high rates will start causing inflation as the cost of borrowing money is a factor of production for many goods and services. As much as I like earning fat interest on my savings, rates probably need to come down quite a bit (though not back to zero, which causes it’s own problems).
Erdogan, is that you? (For background, Turkey’s President Erdogan believes that high rates cause inflation, and up until recently has been trying to keep rates very low to control Turkey’s massive inflation. It didn’t work).
If you are a business and need to borrow money to fund production or expansion, it costs a lot more to borrow that money than it did two years ago. That means your cost of production is higher and you will seek to raise prices. I’m not saying that’s the only reason inflation remains high (greed-flation, shrink-flation, etc. are also factors), but it seems reasonable that this is having an effect.
Higher rates mean that it's more costly to expand with debt, encouraging people and businesses to take on less debt, and thus at the margin, decreasing prices.
Mind you, higher rates don't appear to have done much for housing prices in a bunch of markets (e.g. the US, Ireland and Israel) so clearly the lags are longer than I was expecting, at least.
The relationship between interest and inflation is probably not as simple as people and experts seem to think. It's non-linear, involves hysteresis and also time delays. It's probably not possible to model.
I don't think it's possible to model using simple equations. Given much much better data (which is a total pipe dream), you could probably do much better than the relatively simple models in use today.
High rates don’t impact people without mortgages. There are lots of people who bought in ages ago and move their equity between homes.
At least according to the WSJ and others, there seems to be a decent chunk of investor-owned real estate. Someone probably has a study comparing real estate in countries that restrict ownership by investors to see how much this distorts prices.
Because in the US and Ireland financing for housing collapsed on 2008 and never recovered (so there are no more small and medium sized residential developers in most of the US).
In Israel's case there's literally no space (it's the same size and population as the Bay Area)
> Because in the US and Ireland financing for housing collapsed on 2008 and never recovered
Honestly, I can't speak confidently to the US here, but the Irish building rates were entirely unsustainable before 2008. Like, a fifth of national output was construction, which was definitely way too high.
The lag before construction started again (without the small builders getting bank financing) probably does explain some of the issue.
Usually major building projects (eg. Toll Brothers type tract housing) are financed 7-10 years before the first sale. After 2008-12 happened, the entire financing industry for residential real estate collapsed, so large builders either switched to commercial or folded.
> but the Irish building rates were entirely unsustainable before 2008. Like, a fifth of national output was construction, which was definitely way too high.
Lotta corruption too on the Anglo Irish side by not doing due dilligence into connected developers like Bernard McNamara
> Lotta corruption too on the Anglo Irish side by not doing due dilligence into connected developers like Bernard McNamara
Like, the whole nationalisation of Anglo is why I'm paying shed loads of taxes for crummy services, and you can trace basically half the problems of modern ireland back to that decision. Screw FF.
Yeah, but people need to eat, get to work, etc. At some point businesses have to borrow replace aging equipment, etc. You need some base level investment in productive capacity to simply maintain that capacity. At some point it seems higher interest rates will make this investment more expensive.
And record near 0% rates have led to the richer becoming richer and poorer becoming poorer.
The problem is, the people best suited to exploit near 0% are the wealthy who can take out absolutely massive loans, buy up companies, real estate and more, and jack prices. Which all leads to inflation ~~.
This is how I see it. Current rates aren't high, they just seem high because of the free money that's been available since the 2008 crash. I always thought that we kicked the can down the road for too long and we would pay for it. So far, I think we're still kicking. Who knows, maybe the country's top economists have something going for them and the pullback won't be a crash.
Extreme wealth has a net negative impact on economy. Both because of direct impact but also politicians trying to please them with tax incentives and what not. Plus the insanity of a single person can disrupt a whole sector.
High rates also incentivizes your customers to save now and buy later, slowing sales activity and growth. This increases pressure to control costs.
Trying to engineer a soft landing is hard. It’s like trying to perform a moon landing. There are so many variables: changing demographics, shifting energy production, global macroeconomic events. Time will tell in the end.
I understand why it would increase the cost versus when interest rates are low, but I don't see why high interest rates should cause continuing inflation?
If the rate stays steady it should not drive continuing inflation. Increasing interest rates only effecting shaky businesses. If a business has sufficient cash flow interest rates will have a small effect.
What about them? Sounds like the customer should think through their issues before making purchasing decisions. Do you have something specific in mind?
> If you are a business and need to borrow money to fund production or expansion, it costs a lot more to borrow that money than it did two years ago.
Yes, and so the hurdle rate to break even is that much higher, a higher needed-ROI discourages economic activity as it is much harder to get that ROI, and slower economic activity will hopefully reduce inflation.
> That means your cost of production is higher and you will seek to raise prices.
Or discourage you from expanding, which can have knock-on effects of slower economic activity (hiring fewer works so less competition on labour wages, building few plants so not spending on construction, etc).
Business do not expand for the sake of expanding regardless of external factors: they expand to increase revenues on which they earn a profit on. If the cost of expansion is high(er), and so a larger margin is needed, then the business may forgo expansion if they can't get that margin.
If you know can sell something for 10% over the raw material cost, and your production costs add 5%, then the cost of capital being 2% or 6% is the different between a 3% profit or a 1% loss.
I think the cost of borrowing to purchase goods for production could have a one time hit to prices. The production cycle should price in the new cost of borrowing on the next round.
I wish the article touched on "Reaganomics". I would like a similar article with a discussion of Volcker's policy and the Treasury Secretaries actions.
I tried to write to them with your request, their contact form only allows you to send a questions with 255 characters, hah... worked out to around 30 words.
Except Volcker's interest rate hikes (far outstripping rate hikes recently) brought down inflation. If your model is that high interest rates beget inflation, then it is necessarily incomplete since it doesn't explain Volcker's success.
In fact, most empirical observation indicates the exact opposite.
The fact that unemployment is low signals that we are not grappling inflation properly. You can't limit inflation without reducing employment rates. Those two go hand in hand.
There is a school of thought that the goal of increasing rates is just to control employment rates. It's just a indirect/crude way to do it, and unfortunately, the most effective way the fed has at its disposal.
This is my view as well, high interest rates fuel inflation just because people want higher profit for the risk than they could get if they just rested their money in a bank deposit.
Not at all. In a debt-based economy, rising rates put downwards pressures on capital distributors, since they have to get more than the fed rate back on any investment/loan. Higher rates -> reduced money supply -> increased unemployment -> reduced demand => lower inflation.
That's theatrics. Everyone on Wall Street and Main Street knows the true cost of living — housing, gas, and grocery prices — has increased dramatically more than any Fed-anointed number with the word "inflation" near it.
Certainly not for everyone. If you have a fixed mortgage, and are careful what you buy, you can live like its 2019.
I was at the grocery store a week ago and everything in my basket was reasonably priced for 2019: pork, bread, bananas, carrots and potatoes. Is it a coincidence I happened to buy only things that didn't experience inflation? Heck no. Avoid name brands.
Also if you "have a fixed mortgage" you probably have a fixed mortgage that was locked in at drastically lower rates than current market rates, which is the most advantageous position possible
