Please explain how higher interest rates helps reduce inflation? No matter what, people still have to buy shit. So how does high interest rates get people to spend less? People still need to buy homes, cars, food regardless of what the interest rate is. Those are kind of necessities, so shouldn’t the government do more to make it more affordable?
And if businesses are paying more for a product, then they have to charge the customer more. They can’t charge less just because people aren’t buying. If they do they won’t make any money themselves.
I’m confused. Please explain it to me.
In: Economics
The value of a dollar in the modern economy is based on circular reasoning. At the end of the year, the government measures how many dollars were exchanged and how many goods and services were rendered. If the country only made milk and it made 10 gallons of milk and $10 was exchanged the entire year, each dollar can buy a gallon of milk. If everyone suddenly got a $10 check from the government but milk production stayed constant, some people might want to buy more milk with the extra money they have, but the problem is the milk supply remains the same while demand is increasing. Some people might be willing to pay more for milk, which drives up the price of milk to a new equilibrium where the price is high enough that all the milk gets purchased at the same rate at which it’s produced.
The economy is experiencing inflation; one solution would be to build more production capacity so there is no longer a milk shortage. The government is not in the business of making milk; if investors want to capitalize on the milk shortage, they can start a dairy. The other solution is to slow down the rate at which money is spent which reduces demand. Raising interest rates encourages people to put more money in savings and not spend it, but more importantly, it discourages people from borrowing money because it is more expensive. Fewer people borrowing money means there are fewer dollars flowing in the economy and as long as those fewer dollars isn’t also associated with lower production of everything, inflation is decreasing.
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