So how does this work? I have read so many online columns yet no idea how it works.
Can someone put in a simple way how raising interest rates helps reduce inflation?
How Does Raising Interest Rates Reduce Inflation?
dodgybrothers on 02/08/2022 - 14:38
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Thanks.
Wondering why most articles are based on the US market !
It doesn't matter what market it is based on.
people with loans have less discretional money to spend = less demand
.
Except the current inflation is not demand push inflation, rather input cost inflation for which interest rates have little influence
Its the other way round.
It's demand driven with input cost inflation the secondary, more minor forcing.Can't print $750 billion and expect everything to stay the same price
Can't print $750 billion and expect everything to stay the same price
This guy gets it
@dtc: Australia printed oodles of money. Before you say thats a small green line on that graph that is a part of ALL THE MONEY.
https://www.rba.gov.au/publications/bulletin/2021/sep/an-assessment-of-the-term-funding-facility.html#:~:text=The%20Term%20Funding%20Facility%20(TFF,Australia%20against%20high%20quality%20collateral.
@Boogerman: Cant have a pandemic where the supply chain drys up and expect prcies to stay the same as demand outstrips it
Can't print $750 billion and expect everything to stay the same price
You can.
The GFC bail out to the US financial system went to the banks. Banks had to find people credit worthy to lend to.
COVID19 the money was given to people almost no questions asked and not clawed back.
Whilst I agree that the LNP helicopter cash didn't help, I haven't seen any sign that there is massively more demand on account of money sloshing around (other than the housing market, which is just nuts at the best of times).
In fact what it does indeed seem to be are basic cost inflation on power/etc. driving up some prices, coupled with broken supply systems limiting availability; then everyone else piling in and raising THEIR prices in the hope that nobody will notice in the general rampant inflation (10+%).
Then the central bank makes it worse by raising interest rates (the only thing they know to do) and we haven't even got the the much higher wage demands in a tight labour market yet.
Whilst interest rates are going to have to rise to a valid level sooner or later, now is probably exactly the wrong time to do so - the problems are bigger and more requiring of subtlety than that.
It's like trying to cool a room by opening the freezer door.
@sane: I'd rather they rise now than what's happening in turkey right now.
Although admittedly rising inflation is effectively the best godsend for the nation's future generations as it rapidly devalues savings and houses while wage growth should technically catch up.
@Drakesy: Inflation has a big issue on standard of living, particularly in a globalised world.
I think this current scenario, however, has aspects of a catabolic collapse. Its not good that unemployment is theoretically so low whilst wages are stagnated and inflation has spiked. The system isn't working as it did before covid - 1+1 no longer equal 2. I'm not sure where the next stable point is, but we aren't anywhere near it yet.
@Drakesy: I think interest rates just rock realestate prices, both up and down. What we need is tenant protection. When people can choose lifetime rental contracts only then will realestate settle and people won't need to buy homes. Landlords then can't move us out (unless tenants are bad) or increase rent beyond CPI. And like in other countries when you buy a house and get a fixed interest for life of mortgage so people know what they are up against. We just aren't doing things right! With realestate just being a tool to make money for most prices will always go up and down a lot more than if we had better tenancy protecting - and far less homelessness! This Australian Dream of owning a home is a necessity, unless you don't mind moving every couple of years and facing homelessness and crazy prices.
It doesn't really matter what the cause is though.
If people have less money they are forced to spend less, this reduces demand, which reduces inflation.
You could accomplish the same thing (reduce inflation) by increasing the higher tax brackets and using the revenue raised to pay down debt. Increasing interest rates doesn't reduce debt, it just increases repayments on debt.
Inflation is caused when middle and upper class people have too much money (ie they are not paying their fair share of tax).
However, the ALP will never do the right thing. All they care about are the top end of town.
I have to stop buying coffee from my cafe everyday because I have to put that money on my home loan instead. The cafe then starts to lose customers. To convince customers to come back the cafe owner lowers his coffee prices. Boom, inflation goes down!
Only I live in a really wealthy suburb so everyone can still afford it lol
humble brag
Or the social housing in the Stonnington council
broadcasting you’re a winner in life, you sound happy
And/or Cafe/Owner goes bust, and loses their house, because they can't pay house loan.
Next owner takes over and lowers the price. The previous owner force sells the house cheaply. Win-win for the community.
Next owner makes worse coffee, goes out of business anyway.
@smartazz104: Next owner takes over and lowers the price even more. Plus another cheap house from force sale. You see, that's how it works.
@DarkOz: Then this owner goes bust and shopfront becomes abandoned as no new owner wants it. Instead of buying houses, people start squatting in abandoned buildings thus lowering demand for houses and reducing house prices
I love the idea of greedy business people going out of business because their greed prevents them from adjusting to new market conditions. Like Metricon, with their 1970s business model, pulling a pikachu face over what worked for them 50 years ago to make their family obscenely wealthy not working still in 2022. There's a lot of Australian businesses that are huge today, but still stuck in their 20th century business model mentality. They will complain about Amazon or about taxes paying single mothers income, but they won't actually adapt and change themselves.
It's ok, metricon (and other builders) will just start up again under a new name, without the obligation to their fixed price contracts they got out of due to 'bankruptcy'.
and the same goes for their employees.
I don't think you want prices go down ie deflation. They go up but at a slower pace ie disinflation.
Australian retail finance has the cafe owner raising his prices to make up for the lower turnover - and maybe sacking a member of staff.
More of y'all paycheque needs to go towards your home loan. So you have less to spend in the economy. Fewer people spending means less demand, so that helps to reduce inflation.
And your momma's weight.
What does "…y'all…" mean?
And what is a "…momma…"?@poboy spelling "paycheque" as "paycheque" instead of "paycheck" proves he isn't a po'boy from the South.
Inflation occurs because enough people are willing to pay the higher price. If enough people are no longer willing the pay the higher price then businesses will be inclined to stop raising them.
Currently the only lever the government has to adjust peoples ability to pay higher prices is to decrease their available money by introducing higher interest rates since a lot of peoples main expense is mortgages.
Increase taxes. Reduce spending.
Increase aus dollar so imports are cheaper.
high AUD bad for exports.
Healthy economy needs more exports than imports.
High AUD make people spend their money overseas, instead of locally.
And companies can afford it, globally company profits have never been greater.
Technically the government doesn't have that lever, the RBA does.
The Government has plenty of other levers, none are particularly popular. (Reduce public employees, raise (income/payroll) taxes, reduce government spending etc). There's other supply side levers as well that have bit of sovereign risk, take much longer or risk hurting long term (Gas reservation, fuel excise cuts etc).
All the levers have downsides really, and you also risk over correcting and causing a recession.
less disposable cash after mortgage payments, higher savings rates encourages saving instead of spending.
low interest rates means more spare cash, no incentive to save may as spend it on sh*tInterest rates would need to be higher than inflation, to truly encourage saving over investing then?
Well If savings interest rates go above 7% be plenty of fd people.
stops people buying shit they don’t need, but your right if you need it your better off buying now assuming it’s not perishable good etc.
A little off topic, but during this pandemic you would think that productivity went down, as well as GDP /income, yet prices soared. So we have much less money and things are way more expensive
For some certainly. But there's also many others that actually gained lots more disposable income to spend.
Those in full-time employment (say office jobs) that continued working from home (even till this day) and did not have any travel commute expenses, clothing expenses, as much dry cleaning/washing, daily working coffee/lunch costs, gym membership on freeze, no holidays during lockdowns, no parties/events/sports matches/shows etc that cost tickets/travel/food/drink/clothing money as well as some added benefit schemes for some people whether payments or WFH tax relief etc suddenly found themselves with more available money to spend.
There's probably some added cost in terms of extra electricity usage, more groceries/food delivery etc but doubt anywhere near the reduction in average weekly spending from other items.
Average incomes went up during the pandemic (any short term fall in business incomes was offset by increased welfare and government spending, and then some), but global supply of many things has decreased, and all that extra money is chasing less goods. GDP also kept growing, interest rates until recently were still at record lows flooding even more money into markets.
Really it's a combination of MORE money and LESS goods due to Covid in 2020-2021.
Pour on top of that already existing inflationary pressure, large numbers of Russian and Ukrainian goods effectively evaporating from the global market pushing up demand for alternatives, and China this year having the biggest drop in production of the pandemic due to shut downs.
Productivity in Australia has also broadly increased over the pandemic, albeit a mere blip compared to the currency supply.
You also factor in noone went on holidays, restaurants etc so spend oodles of money on home renovations,cars,caravans. I personally don't know anyone who suffered during COVID. Everyone had more money because they didn't go out.
Have a look at inflation in Turkey; it's insane. Their president has chosen to try and control inflation by keeping interest rates low. Prices can go up in supermarkets 6x a day; they have teams of people who can reprice everything in a few hours. Their inflation rate for June was 79%
I think they were really struggling with their economy, especially inflation, well before the pandemic
well, yes, you're right; that's why I didn't mention the pandemic. I don't know why you mentioned the pandemic. I believe it is down to the president's idiocy. He has sacked 3 central bank governors who were trying to do the right thing - that's how single minded he is. Despite warnings and advice from all concerned governments internationally.
Theory of taking money off people so they can't spend it is true.
Problem is this time around you can see the biggest driver of inflation is fuel price. Either we all start cutting back big time on fuel (or if you see crude oil prices going down due to recession concerns) otherwise inflation will keep on going up.
During the oil shocks of the 1970s it took almost a decade to bring inflation under control. People bought smaller lighter cars. Companies invested in more efficient means of productions and reduced dependence on cheap oil.
If only there was some kind of car that doesn't run off internally combusting oil.
That didn't also cost $50K
whose fault is that? We're practically the only country that doesn't have cheap electric vehicles or the infrastructure to run them. UK and Europe have awesome cheap e-cars that have been around for at least a decade. Our former government worked very hard to remain stagnant; in reality we've gone backwards.
We're practically the only country that doesn't have cheap electric vehicles or the infrastructure to run them
I think you mean tax payer subsidized.
UK and Europe have awesome cheap e-cars that have been around for at least a decade
Please give us good examples.
Our former government worked very hard to remain stagnant
Didn't know government made cars or build charger networks.
You are just complaining about not giving subsidies. It is like people in Egypt complaining about government not subsidizing the rising cost of bread.
@netjock: No, I didn't mention subsidies. You mentioned subsidies - perhaps you can elaborate?
If you don't know how to use google or duckduckgo, here's one in the US; yes we're worse than the US
https://www.youtube.com/watch?v=8LyHPZFtk3o
the following is the one I'd like to see here:
https://www.youtube.com/watch?v=HDWAT0RbTJg&t=0s
Lots of others, of course, way back to the renault twizy in 2010 (UK, EU etc)
@poohduck: Why are you pointing me to Chinese cars when you mentioned UK & Europe?
Why are you posting a video of: Fun Fact! Spark Plug Ceramic vs. Glass. Neutral Drop?
If you don't know how to use google or duckduckgo
Maybe you should use it to search difference between China and UK/Europe. Also how to stay on topic.
@netjock: Oh, I see. There are ships that transport things from China to the UK and Europe and vice versa. Many things in the UK and Europe aren't made in the UK or Europe. I was pointing you (unsuccessfully) to the fact that UK and Europe have these cars (even the US) but we don't
https://fullycharged.show/episodes/3400-electric-car-would-y…
Here's the correct link from previously that you were whinging about; it's not going to make you happy though is it?
@poohduck: That Chinese car is not sold in Europe. Just because it is shippable doesn't mean it is legal. You make it sound like Europe and UK are crawling with Chinese cars. You need to get serious.
Simplez
BYD Atto 3
Meh. As per the news yesterday, flying cars are about to be the next best thing, so buying an EV rn might be foolish.
Also a per km tax on ev is on the cards. Could make them more expensive to running the long term
@Geoff01: The proposed taxes combined with the cost of electricty (which, in theory, will also go down as we move away from coal/gas to cheaper renewables) is still way, way lower than the taxes you pay on every litre of petrol…
@Gina Rinehart: You mean the unreliable and inefficient renewables that caused Germany for one to restart coal power stations due to lack of wind? Those “renewables”? And with electricity prices going through the roof atm, with some countries asking people not to charge their vehicles due to power shortages???
caused Germany for one to restart coal power stations due to lack of wind
Or, you know, not having another source of fossil fuels to burn (Russian gas).
Those countries going through power shortages are still massively dependent on fossil fuels as the uptake/development of renewables is still in progress, so it's hard to blame renewables for those situtations. My point is that when renewables are more widespread, there will be stability and price certainty, particularly with improvements to storage tech (batteries) to help handle surge requirements (+ hydro etc.)
@Gina Rinehart: The trouble in Germany started before the war, but don’t let the truth get in the way of a good story.
Problem is this time around you can see the biggest driver of inflation is fuel price.
No it's not.
No it's not
You can hold off building a new house, buying new furniture, you can also walk everywhere but I doubt you want to walk everywhere.
The most significant price rises were New dwelling purchases by owner-occupiers (+5.6%), Automotive fuel (+4.2%) and Furniture (+7.0%).
Go out into the real world. New house prices are up far more than 5.6%. Fuel is up more than 4.2%. Look at the prices of steel and wood.
Go out into the real world
Why don't you publish you own set of CPI figures and outline the methodology. If it is so great then I'm sure it will be adopted.
@netjock: Steel price is published. Lumber price is published. Housing prices are published. Fuel prices are published. Have a look, it's not hard.
@brendanm: If they are so great then why is it not used as CPI measure?
I could say inflation is 30% because box facial tissue prices are published. Unfortunately it isn't as much of an influence as some people think.
How much steel and lumber have I bought in the last 3 months. Basically zero.
If you build your house with petrol it would have gone up 100% but you don't.
How much steel and lumber have I bought in the last 3 months
What do you think buildings are made from?
This may come as a surprise, but the economy is bigger than you.
This may come as a surprise, but the economy is bigger than you
Here is the surprise: you still haven't come up with a credible alternative CPI that people would adopt?
You point to two products like they are the only influence of CPI and they are a good indicator. They are helpful but not even close to being a key driver.
If you look at your car which might be 2T. If all of it was steel. The doubling of the iron ore price probably will double the cost of the steel component. I could also give you a 2T lump of steel which will be a lot cheaper than your car. Would you like your car manufacturer to peg their pricing to steel? Maybe petrol? Since you can afford to pay twice the price for petrol you can pay twice the price for a new or used car.
@netjock: My point is that the official inflation rate is not representative of the actual increase in prices for people. I couldn't care less about the cost of fuel, I don't pay for it, but I'm sure it almost doubling has been terrible for some, much worse than the inflation figures show.
not representative of the actual increase in prices for people
Which people?
Averages are not representative for individuals but it is average of everyone in the sample size.
You don't know a set of statistics using averages (or weighted averages and seasonality) then you need to under take basic stats.
Which people?
All the people. Fuel goes up a mile, basic fruit and veg up a mile. Anyone can see that inflation is higher than what they have stated.
@brendanm: Here we go. For a person who doesn't pay for fuel worrying about inflation on fuel?
Maybe you just look at price labels and over think the amount people consume.
We are back at the problem of you just poking around 1 item at a time when someone else got a team of people doing the math.
I'd really like brendanm vs Tesla or SpaceX. You might create better EVs or rockets if you really put your mind to it. Just like you have better inflation data but obviously the RBA board don't dial you in on meetings.
Here we go. For a person who doesn't pay for fuel worrying about inflation on fuel?
It's a worry for a lot of others, just because it affects me doesn't mean I don't think it's shit for others.
We are back at the problem of you just poking around 1 item at a time when someone else got a team of people doing the math.
A team of government funded people.
It's a worry for a lot of others, just because it affects me doesn't mean I don't think it's shit for others.
You make it sound like you are serious rather than spreading FUD.
A team of government funded people
Would you feel better if they were funded by Gerry Harvey? You also for privatising Services Australia (Centrelink) maybe Medicare.
Just like your version of inflation, you just pick and choose what fits.
You make it sound like you are serious rather than spreading FUD.
What on earth are you on about, there is nothing to gain by spreading fud, this isn't some low cap crypto.
Would you feel better if they were funded by Gerry Harvey? You also for privatising Services Australia (Centrelink) maybe Medicare.
More daft suggestions, with no relevance to the discussion.
Just like your version of inflation, you just pick and choose what fits.
Show me some things that have gone down in price?
Show me some things that have gone down in price?
Electricity in Victoria.
You are spreading FUD. FUD isn't for low cap crypto. You are just sensationalizing inflation. The average OzB $250k salary with a 3% pay rise would offset all the inflation (provided you didn't spend it all and you are inflation hedged because you drive a Tesla therefore no fuel, electricity hasn't gone up) excluding interest rate hikes.
Electricity in Victoria.
Apparently it just went up 5%? Who cares what happens in Victoria anyway.
You are spreading FUD
No, I'm spreading reality. The government printed money like it was going out of fashion, and has stuffed up.
Apparently it just went up 5%? Who cares what happens in Victoria anyway.
Big words for someone who cares about the other guy. Electricity got cheaper in ACT
No, I'm spreading reality
FUD
The government printed money
Please point to the physical printers that money is coming out of?
People should stop believing it is money out of thin air. Creation of tax payer backed debt has to be paid back (yes the government can go bankrupt). You like most people spreading FUD think it is like Weimar Republic or Zimbarbwe where actual real notes were printed with more zeros added with hopelessly nothing to back it.
In 2008-2010 people called bail outs money printing, helicopter money and inflation didn't take off at the retail level (debatable for shares and property). That was money given to bail out the banks to fix the banks up.
In 2020-21 all that money that went straight to the people with no questions asked and no claw backs. Both "money printing / QE" or whatever FUD term you want to pitch but you know who is the financially irresponsible ones.
aren't rising fuel prices a symptom of something? Along with many other rising prices? Russia's colonialism war in Ukraine for example; and that on the back of covid and its effects on manufacture, shipping, and public spending?
Russia's colonialism war in Ukraine for example
Raising interest rates aren't going to stop the war.
on the back of covid
COVID makes people sick, not fossil fuels so they don't burn. Crude went negative when pandemic began as a lot of people went into lock down and demand dropped.
and public spending
We know most people stayed locked down and didn't get sick but they spent time online shopping
shipping
Theory is ships got scrapped like planes got put into storage due to lower demand. Until they realised they needed them to ship goods people were buying online.
effects on manufacture
You talking about how car manufacturers thought they would sell less cars and cancelled their chip orders?
All of the above supply chain issues were more like people reacting like a classic recession which is demand drop. Unfortunately demand didn't drop and manufacturers and shippers got caught out.
Do you actually know anything? You're just being objectionist via chosen ignorance and outrageous assumptions.
Where did you get "raising interest rates are going to stop the war?" What is that about? Anything?
Why do you think (if you do) we have high fuel prices now?
When I say "public spending", it's what the governments have spent; sheesh.
The rest of your points are actually in line with what I have said "and that on the back of covid". Slow down and think for a second and try to read and not rattle off your assumptions.
You're just being objectionist via chosen ignorance and outrageous assumptions.
If that is the way you want to fight.
I think for you to mention as such you've run out of any reasoning.
Good luck because you know nothing at all.
Russia's colonialism war in Ukraine for example.
Oil is fungible good. EU bans it, so it gets shipped to China/India instead.
The suppliers (middle east) shipping to India/China now ship to the EU.The effect of that in the long term on oil price would probably be negligible. Ironically I've heard that the EU might buy indian oil, even though it's basically Russian fuel.
Since the federal government is a net payer of interest on the 1 trillion dollar government debt they create a new 10 billion dollars each year for each 1% rise in official interest rates.
The 10 billion comes from your tax dollars. If you have $1m in assets and created $100k to pay off your loans everyone still sees you have $1m in assets. Only you think you have $1.1m therefore everyone will take you $1 as worth $0.91 in the real world. FX rate will change in response.
You have it confused, the government is paying us interest on the debt so this effectively stimulates the economy.
You need to think of government debt as private sector savings.
government is paying us interest on the debt
Who is us?
Two thirds of government debt owned by non resident investors, you can thank me later
@netjock: I would not disagree with you. Us can be you, me, Chinese Government, Warren Buffet or Microsoft, anyone apart from the Australian Federal Government. It is just money the federal government has spent but not yet collected through taxation.
You have it confused, the government is paying us interest on the debt so this effectively stimulates the economy.
How does paying interest to, say, the Russian goverment (or the US, Chinese, Brazilian one …), stimulates the Australian economy?
@LFO: Corruption, offshore companies, high class hookers, cocaine and prime property I assume.
If you can be in all 5 then you are well in the money!
And remember that us OZbargainers are the vanguard helping to lower inflation by being tight@rses!
Paying retail is against the national interest.
Accepting lousy service is close to treason.
Overpaying tradies is a blight on our glorious nation!We can all give ourselves a pat on the back for being ahead of the curve…😎
One of the things that I don't think has been discussed is that higher interest rate also helps the AUD. Which lowers the cost of imports which in turn lowers the rate of inflation. I was talking to an economist the other day and I asked what the ratio of of cost push vs demand pull do they see with the current inflation rate. They believe it is around 25% supply chain and the rest demand. With the trim mean at 4.9% inflation in Australian only requires interest rates slightly above neutral.
Understand the theory but instant pain only to those with variable rate borrowing.I have pondered if it would be more acceptable for the pain to be in the form of compulsory saving. Instead of slogging the increase in the OCR to borrowers why not task all tax payers with half the OCR increase by way of a tax payer deposit to your super fund. Would take money out of circulation during any financial crisis, share the load more equitably and indeed may be more palatable to be saving the ‘pain price’ rather than allowing banks to shag around with their margins. Anyhow, just another way of dealing with so called excess funds sloshing about, nobody has checked my empty wallet…
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This article explains it pretty clearly in simple terms with some examples: https://theconversation.com/how-raising-interest-rates-curbs…