With interest rate rises, the people in the most debt suffer the most. With tax rises, the highest paid suffer the most, and the govt has extra revenue to help the ones struggling the most. This is never considered by any govt. Why not?
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Raising interest does slow the economy, but that is just the end result of what’s actually happenning. What’s happenning is that money creation is slowing down. When the Fed raises interest rates, the desire for banks and lending institutions to borrow money from the fed goes down.
If the cost to borrow x amount of money is 2.5% and that is twice as high as it was last year, then it becomes more difficult to sell loans to businesses and consumers. Banks have to make money off the loan, when the base interest rate for then has increased, They need to increase the interest consumers will pay to maintain their expected profits. And because less loans are expected to be made because consumers and businesses can’t afford to take out as many loans, banks must raise the rates even further to make up for lost loans.
This is why interest changes are made in small increments by the fed, to see how the market reacts and slow the economy down at a controlled rate. You wouldn’t want to crank the interest up an alarming ammount all at once, everyone would freak out. If one month you could buy a car for $450/month, and the next month that same car cost $650/month, less people would buy that car. But if you slowly raise the rates, month over month, with the price of that car raising about $50/month in payment, and then keeping an eye on the purchase behavior of consumers, the fed can determine how much demand is cooling down.
The idea is that when demand lowers, businesses will have to lower the prices of things to generate demand in order to sell. The lowering of prices, is exactly what the increase to interest rates aims for. This is known as deflating the economy. Interest rates have a primary cause/ effect on inflation/ deflation. We want a slight monetary inflation at all times, ideally a little less than the fed monetary rate. Usually, year over year about 2%
When there’s worries about a recession, or slow down in the economy, the fed lowers interest rates to make it more enticing for consumers and businesses to borrow money. When money is borrowed, things are bought and sold. More money goes into the economy, work is paid for, jobs are created, the value of things slowly rise because more people can afford it. This is inflation, but controlled.
Now, to your question. Why doesn’t the government just use the power of taxation to slow the economy, well, interest rates controlled the rate of money creation, taxation rate is the rate of monetary destruction. While the government is the largest employer in the US, the government doesn’t create goods or services that exchange an equal value for the taxes.
We get services like infrastructure, police, military, and the rest goes to running it all. The part responsible for running it all is called bureaucracy, which ammounts to the vast majority of government. Business has bureaucracy, granted, but compared to the goods and services created, a business’s bureaucracy is only about 10% of the business, within government, its easily 70-80% if not more. This means that 70-80% of tax money doesn’t return in the form of a tangible goods or services, just money that goes to feed the machine if you will.
Without an effective impact on controlling demand, taxation in the place of interest rate control doesn’t have the same effect as interest adjustments.
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