Robin wrote:
> Can someone explain to me how raising interest rates is
> supposed to reduce
> inflation?
>
> (I presume that the logic goes like this:- higher interest
> rates mean borrowing
> is more expensive, hence less will be borrowed, which in
> turn means lower
> investment and less economic activity).
>
> What I fail to see is why one would want to suppress
> economic activity, as a
> means of fighting inflation. It seems like a blunt
> instrument to me.
Arbitrary raising of interest rates by the Fed, for example, reduces inflation
immediately by reducing the demand for borrowing. Since commercial banks are
able to lend about ten times the amount deposited in them, then less money is
created as debt, with reduced inflation as the result. There is only so much
the Fed can do, when interest rates in the long run operate on supply and
demand, just like everything else. The problem in the U.S. right now is that
we have been gutting our manufacturing base to the point where less than 10% of
employment is in manufacturing. Hence, the financial sector is the tail
wagging the dog. Not good.
Secondary effects as you describe also reduce inflation, but as you say, it
reduces economic activity. The trick is to find a balance for a healthy
economy. The Fed was created to maximize the profits of banks, which usually
corresponds to a good economy. As we see now, that is not always the case,
especially when so much financial mischief is allowed.
I find it shocking that these issues are not covered in an elementary
education. They are not difficult to understand, and the average voter could
make up his mind based on information rather than the general nonsense spewed
forth by politicians. If the average person knew how the banking system works,
I doubt there would be a Federal Reserve, and the authority to issue currency
would be returned to the Congress where it belongs.
As we see from his recent appointments, Mr. Obama was running for Bush's third
term just like Mr. McCain, at least from a financial standpoint. Actually, it
seems we are going to be treated to Carter's second term, while experiencing
both Clinton's and Bush's third term. Who'da thunk it?
M.
