Inflation and Interest Rate

Economics Economics Questions
1

I’m trying to understand the following articles and I have some questions:

Can someone give examples here?

What does it mean to have a low interest rate and what does it mean to have a high interest rate, in the free market?

Does this loan rate refer to bank loans or what?

And what about this:

Market interest rate

Why is that? Why does inflation make the interest rate decline while everything else gets more expensive? It seemed to me as if everything should inflate.

By buying things are people actually causing inflation (by inflating the money supply with paper they had stashed away under the mattress) ?

And now, a quote from this page: http://blog.mises.org/archives/007629.asp

In this context, the interest rate is considered to be the higher price he has to pay for immediate satisfaction. How does this relate to the artificial changes in the interest rate?

Now, a quote from this page: http://mises.org/easier/O.asp#10

What’s the market interest rate? Give an example. Is it like the price payed for immediate satisfaction?

I heard on the news yesterday that Romania’s National Bank would lower interest rates. What does this mean?

2

Wow…that’s a lot. Here are a few of my thoughts. There’s no way I can respond to all these.

Here is your typical money market graph:

The CB can change the interest rate a number of ways, mainly through open market operations. An expantionary monetary policy means the CB buys up bonds and uses its freshly printed money to pay for them. This increases the money supply (from Sm to Sm1) and lowers the interest rate (from ir to ir1). When private banks increase money through lending it has the same effect.

The money under matresses are just excess pieces of paper that were printed by the CB. The scenario above is excessive, it’s like your describing 1920s Germany where people were using money as firewood. However, people to flee to commodities like oil and gold to rescue themselves from the effects of a currency quickly abandoning its value. People do not cause a rise in prices, or an inflation of the money supply. Only the CB can do that:

3

In a true free market, a low interest rate means that people are willing to defer current consumption for future consumpion. It is easy to raise capital and start new businesses. Suppose interest rates are 2%. In that case, a business must return more than 2% in order to be profitable. Suppose interest rates are 5%. In that case, a business must return more than 5% in order to be profitable.

With higher interest rates, marginal new businesses are not started.

In a true free market, interest rates should be nearly the same for all market participants, adjusted for risk. In the present, banks and hedge funds get to borrow at very attractive rates (slightly more than the Fed Funds Rate). Large corporations get to borrow cheaply (2%-4% more than the Fed Funds Rate). Individuals may not borrow at all, or only at a high interest rate.

Usually, interest rates mean “Fed Funds Rate”. Based on how risky the borrower is, you pay “Fed Funds Rate” plus more.

In the present, there is no free market interest rate. Interest rates are artificially set by the central bank. This causes all sorts of problems, including the Compound Interest Paradox.

In a true free market, interest rates would represent the willingness of people to forego present consumption for future consumption. For example, I’m willing to do surplus work now in exchange for other people providing me goods when I’m retired. In the meantime, I invest those proceeds, earning the free market interest rate.

When a central bank lowers interest rates, it is causing inflation and bailing out banks. When interest rates are lowered, outstanding loans become worth more. The benefits of inflation are concentrated in the financial industry.

Monetary issues are really complicated. I have lots of good bits on my blog. There’s a lot of lies and propaganda circulating regarding fiat debt-based money. Some people are able to understand the truth, and others can’t take it.

4

First off, ignore the Compound Interest Paradox as it’s been discredited on multiple occasions yet the links seems to show up in every thread that has anything to do with money or interest.

Interest is related to the supply of available loanable funds.

If there is a bunch of money the cost to borrow that money will be low (low interest) and if there is a shortage then it will be high (high interest). The law of supply and demand at work.

Saving is showing a preference for ‘future goods’ over ‘present goods’ and in order to make the money ‘work’ most people will save or invest (really the same thing, deferring present consumption) which is the source of the loanable funds.

They increase the amount of loanable funds with no underlying change in time preference on the part of the market participants when they inflate the money supply. As there is a higher quantity of loanable funds available the price to borrow these funds drop.

Everything else gets more expensive because there is more money chasing the same amount of goods and services which makes each and every dollar worth less in comparison. The more of something there the less its worth and in the case of money this means it takes more of it to equal the same amount of goods pre-inflation.

I believe that’s the article where they talk about the three phases of inflation.

This is the final phase, hyperinflation. People trade their money for anything because if they hold on to it it will become worthless. The spending doesn’t create the inflation but is the inevitable result of runaway inflationary policies. Think Zimbabwe with their million percent inflation or whatever it is.

I think since there is only a two hour difference between want satisfactions there would be no effect from artificial interest rate changes unless he happened to be in Zimbabwe and the money is devalued as fast as they can run the printing presses and buy stuff.

It means they will increase the money supply to drive down the cost of borrowing money.

I don’t know how Romania’s central bank does this but the US Fed usually just buys something in exchange for newly created money, doesn’t really matter what they buy but they mostly buy government bonds off the open market.

I would suggest reading the part about time and interest in Man, Economy and State–or the whole book for that matter as they take you from the very basics up through the complex stuff–as Rothbard does a much better job of explaining it than I do.

5

What is the government trying to accomplish in these 2 cases by:

(1) Increasing interest?

(2) Lowering interest? Here it’s been said that they’re trying to encourage investments, so in this case it would mean that in case (1) they’re trying to discourage them?

6

  1. Increasing interest rates is about crashing the money supply and causing a recession. The “official” excuse is “fighting inflation”. Raising interest rates causes the money supply to shrink due to the Compound Interest Paradox. (It’s all about the Compound Interest Paradox. Don’t let the trolls distract you.)

  2. Decreasing interest rates causes a boom and asset bubble. The new money is printed and spent by financial industry insiders. They are the recipients of a massive State subsidy. Via inflation, a lot of wealth is transferred from the productive sector of the economy to the financial sector.

Federal Reserve Notes are literally work permission points. When the money supply crashes, people lose their jobs due to a shortage of work permission receipts. When the money supply expands, the people who print and spend the new money hire more workers.

7

The Compound Interest Paradox page sais this:

But the Wiki page on Fractional Reserve Banking sais this:

Who is right?

8

They both say almost the same thing. However, the wiki page does not add in the effect of interest, which is the essence of the Compound Interest Paradox. Mainstream economists do not acknowledge that the Compound Interest Paradox is a problem.

9

FSK, with regards to your replies for points 1 and 2, what, then, is the correct action if both ‘Increasing’ and ‘Decreasing’ interest rates has a pervasive impact on the economy? Surely interest rates have to move somewhere as loan-able funds change in volume, unless you infer that interest rates should be permanently fixed or abolished altogether.

Personally, and whether rightly or wrongly, I see the system of fiat credit as just another chapter of the calculation debate where the State will always fail to arbitrage a price, in this case a rate of interest; just like the lemon industry would be devastated if suddenly governments decided to arbitrarily set the prices of lemons.

That being so, couldn’t interest base rates be set completely by the market, even without gold backup? Those banks who held more oil and gold against their credit would surely see their printed notes rise in price viz. banks that held less; market makers would trade in the arbitrage of these notes and produce some sort of convenient ‘Consumer Note’ that would be traded just like current currencies. We might even see the obsolescence of national currencies between liberal nations (the English speaking ones, for example) in such a system.

10

That’s entirely my point. The correct answer is “Who needs a central bank? Interest rates should be set by the free market.” The Federal Reserve is completely corrupt and fraudulent.

A central bank fixing interest rates has the same damaging effect as price caps or price ceilings on the price of lemons. You may think of “Rise interest rates” as “Price cap on lemons!” All of a sudden, people stop making lemons. You may think of “Lower interest rates” as “State subsidies to lemon growers!” All of a sudden, the market is flooded with lemons. The Federal Reserve alternates between “Price cap on lemons!” and “State subsidies for lemon growers!” The central bank alternately floods the market with capital, and restricts the supply of capital.

You can have credit-based fiat money with no central bank. The State directly prints and spends new money into circulation.

Alternatively, there’s my favorite “Who needs a government at all?” In that case, interest rates would be completely set by the market. The decision to use gold or silver or something else as money would also be set by the market.

11

There, fixed it for you.

The only one I see trolling is you by constantly pimping your ‘spam’ blog while refusing to answer any criticism leveled against the theories contained with anything other than ad hominem attacks.

Thereby negating the Compound Interest Paradox…

Umm, yeah, it has nothing to do with the liquidation of malinvestments I suppose.

Care to explain this bit;

That sounds like a bunk theory, literally speaking of course.

12

I don’t know about the compound interest paradox, but he seems right that the Fed pretty much fixes the interest rate, i.e. that it’s just a specific form of price control - or am I misunderstanding you?

-Jon

13

The Federal Reserve is totally a price fixing cartel. The Compound Interest Paradox is a subtle negative consequence of this price-fixing cartel. The Federal Rervere is literally communist.

The Federal Reserve can’t “manage the economy” any better than FEMA can help clean up after a hurricane. Unlike FEMA, the Federal Reserve has an infinite budget, which places virtually no limit on the amount of economic damage they can cause.

Debating trolls is pointless.

14

Yeah, that pretty much goes without saying as that is their main job to allow the banks a steady supply of money without having to bid on it in competition with other banks.

I was just kind of wondering how he justified the interest == work other than the taxes must be paid in greenbacks statement.

Didn’t get an answer as always because there is no other blog post to link to apparently.

The problem with that statement is that you never once tried to defend your pet theory with anything other than claims to ‘incoherent babble’, ‘agent of mainstream economics’ and whatever else you could come up with to discredit the man while completely ignoring the counter-point presented. Not a single time. Ever.

Kind of like right now, you refuse to even acknowledge that you yourself presented the very counter-argument that is the core of the case against the Compound Interest Paradox by calling me a troll not worth spending your time on.

Yet every single time the subject comes up it is almost a rule that there will be a link to your blog promoting this theory as fact. You are intentionally spreading misinformation for whatever reason and just can’t seem to realize this.

This is just dishonesty in the highest degree IMHO.

15

Aside from your pet paradox (which I’m surprised to see you still cling to - despite all previous arguments), I think I almost agree with you. However I don’t think the Fed raises rates to crash the money supply and cause a recession. The Fed is, as you say, simply the head of a cartel - the banking industry. That cartel makes the vast majority of it’s money by pulling it out of thin air. One of the side effects of this, however, is that they’re debasing the currency that they monoploize in doing so. They need to inflate to make money (that’s precisely where most of their wealth comes from - confiscated via inflation). However if they inflate too much, people start to loose faith in the money’s ability to do the job it was built for, which is to hold it’s value (at least until they can spend it) and you end up with Zimbabwe… which absolutely cannot happen - and even the Fed is aware of that.

As such, I think when the Fed raises interest rates it genuinely is to combat inflation - at least ostensibly. They can do this via other means as well, of course, like fudging the way that they calculate inflation (chain weighted indexes and hedonics etc.). But if people start to notice that money is loosing value quickly and they start putting their savings elsewhere (e.g. in non-US dollar stocks) then the Fed starts to loose it’s grip. If people start loosing their jobs or otherwise become unproductive, then there’s less loot to plunder - so the Fed has an interest in theiving less from the nation than it’s surplus, at the very least. As such, it’s generally better if inflation falls short of GDP growth. So they may very well raise interest rates to curb the level at which they’re inflating the currency down to more sustainable levels. In the long run, however, the Fed as the head of a banking cartel has a most definite interest in overall inflation, but they have to be very careful not to milk the cow to death.

Of course, the banks themselves are only the first (most obvious) beneficiaries of the new money. The financial industry and all the other people that borrow at subsidized interest rates are the next beneficiaries and so on and so forth… Rothbard explains all of this much more clearly than I could - suffice to say that the Fed certainly has it’s cheerleaders.