How does raising interest rates help inflation
Why are governments all over the world increasing interest rates? Interest rate hikes will not solve anything but make things worse for the common man. What were they thinking? Were they trying to induce a recession? I just do not understand why the fed interest rate hike in 2022 was carried out. The poor and the less fortunate will suffer espcially those without substantial savings. How does raising interest rates help inflation? Everything will go up in price from mortages to car loans, which is an artificially created additional inflation. This will cause a drop in Demand resulting in retrenchments and job losses and will spiral downward the loss of Demand even further.
Commodity markets not functioning properly
Have you looked at the commodity markets? Why are commodity prices rising? Who are benefiting from the commodity price hikes? Is it the farmers, the smaller businesses or the general public or the third-party raiders of the commodity exchanges - who do not represent Supply or Demand? Personally, I think the commodity exchanges have become an overcrowded greed feeding fest without a care in the world but the reality of increased price afflictions. Do we need an alternative system? Just take a look at the petroleum industry.
The chart above is from Yahoo finance.
This chart of wheat prices is from businessinsider.com
Here, we can understand why wheat prices have gone through the roof as the supply has been curtailed.
The main problem here is the Ukraine Russian war. The common man suffers at the higher cost of electricity, gas, petrol, diesel and other commodities but the petroleum corporations enjoy huge profits. Something is wrong here, right?
Increasing interest rates not effective
Remember, I developed this equation many years ago in my articles to ex-President Barack Obama but my computer was stolen:-
D – S = kI . . . the Demand Supply Equation
D is Demand
S is supply
I is Inflation
K is a constant.
If Demand increases Inflation increases. If Supply decreases, Inflation increases.
Let me explain why I differ. When you have an increase in Demand, hiking interest rates is effective. For example, housing loans, car loans and business loans get more expensive and so it curbs demand and slows growth to more moderate levels. This becomes effective in an overheating economy or to prevent an overheating economy.
If the Demand side does not increase it is of no use increasing interest rates. An increase in interest rates under these conditions causes Demand to shrink and the economy can collapse into a recession.
It appears that most of the commodity price hikes are caused by Supply side shifts. The Supply of commodities has reduced, due to the Ukraine Russia war. This makes it appear that Demand looks greater when in actual fact there is a shortage of Supply and hence the price increases are due to the upset in the Demand - Supply equilibrium caused by the Ukraine Russia war.
No use increasing interest rates
It is of no use increasing interest rates. What governments around the world need to do is to stop the Ukraine Russia war, Ukraine gets back all its territories and search for alternatives to alleviate the loss of Supply.
An alternative non political approach
Many in the West are arguing over right wing, left wing, socialst or fascist or democratic or center politics. Forget about the politics as these will most likely be based upon personal feelings. Many years ago, during the Great Recession, 2008 to 2011, I sent ex President Barack Obama my book on an alternative theory of economics which was very mathematical. In there I explained that the best approach would be to help the majority of the population, instead of looking after banks and the rich.
The figures in the charts below are fictitious but give a clearer picture.
When governments focus on raising the wealth of those lower down, then the general population will benefit. As a result many businesses will benefit directly from these wealth improving policies. This can be done by improving health care and lowering its costs, lowering interest rates so that the less fortunate can purchase their first homes, providing good education and training for those who need it, espcially the school leavers.
You can see why increasing the wealth of the lower income groups will increase Demand and bring about greater prosperity. Most likely many new businesses will start up and more investors will enter the country to benefit from the increased wealth of the population.
The Ukraine-Russia war is upsetting the economic balance and no amount of hiking up interest rates will solve this loss of Supply of cooking oil, gas and other commodities. I suspect that ex President Barack Obama never understood my theories, that is why America is hiking up interest rates without taking into account a Supply shortage. Why is the FED interest rates in 2022 going up?
If you want to know more about my work please checkout my article.
- Dr. Peter Achutha, 28th August 2022
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