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Economics question...

Could someone please explain to me why, if prices on everything go up due to inflation and people are having trouble affording the things they need, why does the gov't raise the interest rates and tell us it is to help curb inflation? Seems to me by raising the interest rates, they are adding to the list of things we can't afford.

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Heartlander · 80-89, M

Inflation is a result of too much $$$ chasing too few goods. So, by raising interest rates it (hopefully) dampens the demand, because many things are purchased on credit. In effect, the cost of credit would reduce demand, and reduced buying would hopefully then force suppliers to lower their prices to move their inventories.

Lower prices would seem to encourage cash buyers; because they don't have to pay the extra cost for credit. But raising interest rates also gives people with cash an incentive to save rather than buy.

For a good example, look at what rising mortgage rates are are doing to the cost of real estate. With the higher interest rates, fewer people can afford to buy a home, and with reduced demand, home prices should come down.

But all of the above is chancy and may backfire because there's much more to it. Like inflation also causes employees to demand more from there employers, and higher interest rates also affect corporate borrowing. Also a lot of business and consumer credit is variable and raising interest rates on existing credit can push somme consumers and businesses over the edge. This happened just 12 or 15 years ago, and it looks like it may soon be happening again.

Ferric67 · M

@Heartlander I've always felt that our current predicament can achieve a correction if there is an Increase in supply.

Heartlander · 80-89, M

@Ferric67 yep. Increasing or decreasing supply would have the same effect as decreasing or increasing money. In today's situation it's both. Biden decreased oil supply, which is a component of practically everything we buy, and he also increased money supply. The result is record inflation.

Budwick · 70-79, M

@Ferric67 That's an interesting take.
Especially since there seems to be 'supply chain' issues for darn near everything.

Heartlander I think responded well in regards to oil.

Ferric67 · M

@Budwick I'm big in buying up oil stock, I've been lobbying for them for months

Heartlander · 80-89, M

@Ferric67 It took me a while to figure out what was going on with oil stock. Just a few years ago the big oil companies were losing $$ by the billions and in some cases were paying more in dividends to their stockholders than they were earning, and even if they were losing money. All the advisors said "avoid-avoid-avoid" because they couldn't sustain the dividend payments and when the day comes that they have to cut them the value will drop to single digits. And that created a general rule for me to not own stock in companies where dividends consumed most of the earnings.

But in hindsight (duhh?) oil company executives have to hold on to their dependable stockholders, even if it means paying out more than they earn for as long as humanly possible. Otherwise, the board and chief executives risk getting fired at the next stockholders meeting. So what we are buying in most oil stock is management stability and what we are getting in return is a reward for our trust in them.