The Feds have agreed to raise the interest rate again as a hedge against inflation. I don’t get it. How does this help the economy? Didn’t we have pie-in-the-sky interest rates late in Carter’s term AND double-digit inflation? Doesn’t this hurt the flow of money? Why would the consumer wish to buy anything esp. a house or car?
Also, articles in the Business Section say that unemployment is also a good thing. How? What would be so bad if everyone were somehow gainfully employed? If everyone had some money to fuel the economy, this would be a bad thing?
I just don’t get it. Have we permitted these ridiculous theories to mute the voice of common sense?
The FED feels demand is starting to overtake supply, especially in the labor markets. This will put presure on prices causing them to increase.
Raising interest rates increases the cost of borrowing for businesses and consumers. It is assumed that this will cause less spending, thus reducing demand.
It seems kind of wacky…but this policy as kept the economy growing since the mid-80’s, with the exception of the Recession at the end of Bush’s term which was caused by the tax increase and the increase in oil prices from the gulf war which lower consumer spending and confidence.
This question should to GD where religious discussions are held.[/IMHO]
An unqualified general answer is:
Raise rates = make it harder for businesses to get money so they can not expand (expand too fast, Greenspans view). Raising rates makes it a bit harder so does not stop or inhibit growth immediately just apply a break.
The bond market could do this on its own and generally does but has not over the last several months - another reason to raise slightly.
In a broad sense that’s part of the intention. Stop spending = less liquidity etc. less money around, slowing expansion (Greenspans desire).
Yes and no. Depends on when and the relation of how much to the state of the economy. Right now there is a lack of workers driving the cost of labor to business up. More costs of production needs to be met with an increase in prices = possible inflation.
The opposite of what I said could easily be supported as there is no ultimate reality in economics.
OK, Kknick34, but what exactly happened under Carter? Were the Feds slow to act? Or, perhaps it was the fault of the second oil embargo of the 1970’s and/or other factors that started a major downward spiral in the US economy? I mean, I witnessed many major businesses (as old as 80-100 years) close their doors. Please fill me in on what brought us into such an economic nightmare?
If everyone were employed, then business would be desparate for new labor. If there’s a shortage of supply for any product, the price goes up. Ergo, the price for labor would go up - wages. People would be enticed to switch jobs and would get paid more. Good thing, right? Probably not.
At the same time, 2 negative effects would happen: 1.) these businesses would need more money to pay these workers and would end up raising the prices of their goods and services to raise this money, and 2.) With all of the richer workers out there, they’re feeling richer and are willing to pay more for goods and services and companies raise their prices to accomodate the demand.
Either way, prices go up. That’s inflation and that’s bad. Inflation is a cycle - once you get in it’s hard to get out. And the cycle starts spiraling.
When the government says unemployment is good, what they’re saying is that having a little unemployment is good because it provides a “cushion” to the economy that prevents the above effects from occurring. This theory makes logical sense, but not only that - it’s been observed in real life in virtually every situation where data is available.
Some of the questions today, however, is that our economy has been humming along for the past 10 years and we have yet to see any of the signs (“indicators”) that would show inflation is about to start up. Greenspan still doesn’t believe the rules have changed all that much and is afraid that inflation is going to come eventually and it’s going to come harshly to make up for lost time. Kind of like a hole in the dike.
The high interest rates you remember from the Carter administration were directly resultant FROM inflation. Once an economy gets into an inflationary cycle, banks start jacking up interest rates to be sure that the money they loan out “keeps up” with the prices of real goods - that are increasing do to the effects noted above.
The theories aren’t necessarily ridiculous. If you think they are, then why are you even bothering asking anyone else’s opinions on the message board? They may be a little inaccurate, but they’re not ridiculous.
It all about the money supply. When the fed raises interest rates, they are trying to slow the growth in the money supply. Why is the growth rate of the money supply important? Because the money supply can be used as a catalyst to dampen or expand output.
When you increase the rate of growth of the money supply, it tricks people into thinking they have more money, therefore they spend more, hense more output. The problem is that you can’t trick people forever. Utimately people build up inflationary expectations. When this happens, the only way to jump start the economy is to further increase the growth rate of the money supply. This in turn will raise inflationary expectations, forming a deadly inflationary spiral. This is what happened in the '70s. The only cure is to drastically cut the Money supply, sending the country into a deep recession, which over time will cure them of their inflationary expectations. This is exactly what Volcker did in the early '80s.
The lesson in this is don’t let inflation get a toe hold, because its very costly to kill it once its established
There’s something about inflation I don’t understand. According to Economics 101 in junior high, inflation is the result of demand exceeding supply. Or put in different terms, is when money becomes devaluated relative to goods and services.
Now if inflation is just that money is worth less, then why don’t wages automatically inflate at the same rate as prices? After all, isn’t labor a commodity? But if wages do go up, then prices are jacked up again, leading to the dreaded wage-price spiral. Most people I know would use the term inflation to mean an increase in the real cost of living.
In inflationary times, labor costs do rise. However when someone gets a 10% raise, they rarely attribute the raise to inflationary pressures. They feel the raise was deserved due to increased productivity. In reality a 10% raise in times of 8% inflation translated to a 2% raise (possibly due to increased productity) and 8% raise due to inflationary pressures.
Although people rarely thank inflation for their raises, they often curse inflation for the erosion in purchasing power it brings.
The biggest losers in an inflationary economy are those with the most capitol. Now, wages will always lag behind consumer prices - so really everyone gets hurt. But its far worse for you if you have money in the bank - because all this money is worth less than it used to be and the increase in interest rates really does not even this out.
Incidentally - the economy is inflating all the time, just slowly. Wall Street closely monitors changes in the Consumer Price Index (CPI) to try to guess if the amount of change in the last month will be enough to induce the Fed to raise interest rates. Its all a big horse race really.
The biggest losers in inflation are people holding cash (i.e. under a mattress or in their pocket). The safest place is to obviously convert your cash into an asset, but putting in the bank isn’t a lot worse. At least the bank is charging interest to try and keep up with inflation. It may not do a good job at it, but holding cash in your hand earns nothing at all.
There was, almost, maybe. John Von Neuman was trying to axiomize economics; his game theory was the start. It has been debated since on if he was making any headway or not. Game theory deals with situations of at least two parties, where each has an influence on the outcome, and in which some economic transaction takes place. - There’s a book available on John von Neuman by the same guy who wrote the “Big Secrets” books: Uh , , , William Poundstone, me thinks. Anyway, it’s an interesting read, in narrative style. Von Neuman’s volume (the big one that he co-authored) on games and economic theory is arcane, technical material. That he could remember all that stuff is truly staggering. - MC
Well shucks, I have one of 'em right here after all: Theory of Games and Economic Behavior by John Von Neuman and Oskar Morgenstern. ISBN: 0-691-00362-9. - MC
My God, how many economics folks are on the SDMB? I’ve answered economics/quantitative type questions before, but this is the first time I’ve seen such an outpouring of good macro policy illumination. Anyway, for the OP, economic policies can seem counter intuitive at first glance, such as low unemployment is a bad thing. You have to go the next step and examine the consequences of very low unemployment, e.g., at what point are labor markets so tight that wage pressure starts to rise faster than productivity? Anyway, we try to make these measurements as scientific as possible, using tools such as econometrics (basically overly complicated statistics). But in the end, human behavior is involved in the economy (duh) and you can count on behavior that isn’t always consistent with theory.
Inflation is also bad because it distorts the information that travels with money. The market acts like a communicator of information, carrying information to those who need it through prices. The price system therefore acts as a controlling factor in economic production, and it’s part of what makes a free market economy so efficient.
Along comes inflation, and throws the price system out of whack. It becomes harder for producers to figure out what people really need based on price, so inefficiencies crop up.
Also, in a country with graduated tax rates inflation can cause ‘bracket creep’, in which you get taxed more and more due to being put in higher tax brackets, while your real earning power doesn’t change. One of the reasons Reagan racked up those deficits so fast was because inflation collapsed right around then (give some credit to Reagan, more credit to Paul Volcker, appointed under Carter). When inflation collapsed, Reagan lost the automatic tax increases due to bracket creep. It’s a factor not often mentioned when people discuss the economic factors in his first term.
Oh, great. First inflation, then grade inflation, and now course inflation. What’s next, economic seminars in kindergarten?
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I repeat “ridiculous”. I had a macro course where we did a case study of country “A” and “B”. “A” grows a glut of pineapples and few carrots and “B” is just the reverse…due to environment, etc. You’d think, then, that “A” should export pineapples and import bananas. Logic would dictate that, but oh no! We “proved” that “A” should import pineapples!
Of course! Whatever was I thinking! And a sinking ship should take on water, not bail!
I’m sorry if I sound cynical, but when unemployment is knocking at YOUR door…I’ll be sure to remind YOU how this is a GOOD thing for all of us! I also default to the old jokes comparing economists to weathermen, but at least weathermen have a fighting chance!
IMHO: ridiculous! And, I regret that these “theories” of a very unscientific science govern out lives to the point where we are victims of the mighty dollar.
Let’s not forget there was another inflation at work during the 70s – cost inflation, specificaly the cost of oil.
During the first oil embargo (1973), prices shot up. Even after the embargo was lifted, prices stayed higher than before. During the remainder of the 70s, industry invested in trying to find substitutes, replacements, etc. That’s why everything about the late 1970s cars was so crappy – manufacturers changed the formulation of paint to get rid of oil, reduced the weight and engine size to use less gasoline, all part of the domino effect.
Unfortunately,reducing our dependence on oil proved a lot harder and more costly than anyone had thought, and when the second oil embargo hit (1979) it was the final blow for any hope of economic recovery, as well as the Carter administration.
The price of oil came back down in the 1980s and inflation eventually subsided. However, anything that hints at an interruption in the oil supply (1990 -Iraq vs. Kuwait) is enough to send the economy into spasms.
But the 70s proved why we’re still dependent on oil. The addiction is cheaper than the cure.
John Kenneth Galbraith would agree with your assessment of the futility of raising interest rates to rein in inflation. God help me, I am beginning to see the allure of the neo-Keynesians. The same effect could be obtained much more directly by raising taxes and having the government sit on the surplus and not spend it. Politically, that is unpalatable. However, if the government does succeed in paying off the national debt (yeah, right), it will lose an extremely handy (and maybe effective) monetary tool. At that point, it will have to rely on tax increases and decreases for its fine tuning. Anybody want to bet that that will be timely and effective?
that “A” should import pineapples!