"I am once again asking for" a common sense explanation for how increasing interest rates will reduce the prices of retail food and gas.
(This should be the new Deleuze meme.)
(This should be the new Deleuze meme.)
- When interest rates go up, the cost of borrowing goes up because you have to pay back more over time.
- When the cost of borrowing goes up people borrow less.
- When their is less borrowing their is less money in the economy. Less of a currency trying to purchase the same amount of goods lowers prices.
Say a company buys a $100k asset, and they can use it to generate $10k in revenue. That's a profitable investment at 5% interest ($5k), but not at 10% ($10k). So at high enough interest rates, it's not economically viable for that company to expand. That lack of expansion has upstream implications, and can have a cooling effect on asset prices at broad levels.
Well asset prices aren't the prices of food and gas.
Borrowed money is rarely spent on food and gas.
You can be stupid and talk about buying food and gas on credit cards. Very few people in this country will stop buying food and gas to prevent default. People need food and gas to survive. So it's not really the borrowed money that is spent on food and gas.
By this logic, why doesn't Congress illegalize travel? Is that going to reduce the cost of travel? Will that reduce CPI, which measures prices, not demand?
> Or they won't buy another TV,
What if we illegalized buying TVs? Would that make TV prices fall? You think that is going to reduce CPI?
I'm not saying your explanation here is stupid. It is the first one in a while that seems to at least appeal to common sense. I am just trying to show that CPI measures prices, it does not measure demand or supply alone for goods.
> With less people competing for precious gas, its prices drop.
Gas prices rise and fall all the time. Lots of factors go into its price. You could illegalize gas, would this cause the price of gas to rise or fall?
> By this logic, why doesn't Congress illegalize travel? Is that going to reduce the cost of travel? Will that reduce CPI, which measures prices, not demand?
Hey, you asked for a "common sense explanation" how the policy works, and people gave it to you. If your intention was "I want to debate unrealistic what-ifs with as many people as possible," then you could have made yourself clear in the first question.
Because then the money just gets spent in other places shifting around the inflation.
Is person B going to stop buying food and gas?
If person A holds on to the borrowed cash and doesn't spend it, that money doesn't circulate (the velocity of money decreases).
If person A doesn't take the loan, there is less money in the system (money supply is reduced).
If there's less money circulating, people won't "bid-up" the prices of food and gas as much, reducing their price (assuming constant supply of food and gas).
That's the theory anyway, they don't say it in plain terms like that though.
People need food and gas to survive. They're not going to stop buying food and gas, unless they are dead.
Just because something is 'essential' doesn't mean you'll always spend the same amount on it regardless of your economic situation.
I would not put instant ramen and a steak in the same "food to survive" category.
Of course, whatever the Fed does may be counterbalanced by supply-side issues, whether economic or political; a warmer-than-expected winter moderating gas prices, or executive actions impeding investment into O&G raising prices, and so on; and other demand-side issues, such as more helicopter money sprayed against fixed supply.
By some measures, it's not even succeeding in inducing a recession. Demand isn't even necessarily declining - you would need a common sense explanation why the rate of increase in demand doesn't sometimes fluctuate or go down anyway, in the absence of fed action.
The Fed's tools are extremely effective at taking a huge shit on bond prices. They have huge financial impacts. But you are not giving me a common sense explanation for how raising interest rates will reduce the prices of food and gas.
It will not. The only way to reduce prices of oil/gas and fertilizers (for food) is to bring back the amount of oil/gas and ammonia that went offline due to Russia. There is no amount of digging anywhere in the world that will quickly replace this much lost natural resource.
What raising interest rates will do is cause less spending in all non-oil/gas goods and services. This means every other industry must expect a reduction in revenues because the average customer is going to be spending more on oil/gas and food.
In other words, the choices for companies are: be ok with reduced revenue or be ok with reducing prices.
The choices for individuals are: be ok with consuming less non-oil/gas/food things or sell assets to fund oil/gas/food things.
Brent has been in the $90s for a while now. That's equivalent to $65-$70 from ten years ago, which also wasn't a problem then. It's very modestly elevated at present.
Natural gas may be a different matter, although the Europeans look like they can have that permanently solved over the next few years through diversification and greater energy conservation.
https://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=M...
Without those, the price of crude oil would likely be higher than it is at the moment (although hard to say how much higher). The fact that China is still pursuing a COVID-0 policy has also helped keep global demand depressed - but we can't rely on that indefinitely.
Isn't a serious problem, yet. That's because China is offline and EU is still purchasing oil from Russia.
At least this has a modicum of common sense to it.
As others have pointed out, oil prices fluctuate all the time though. So do food prices.
Gas can affect retail prices, because to me, common sense says, you use gas, not oil, to move food from wherever it is to the supermarket and into people's carts, back to their homes. And gas prices are not oil prices. And a lot of the price of many goods is, secretly, gas, because that is how the people get to where they work, how the goods that are otherwise useless without transportation get to where they're sold, etc.
> What raising interest rates will do is cause less spending in all non-oil/gas goods and services.
So what? The CPI, even the "core" CPI, is food and gas, or food and gas in disguise.
Even if you buy less clothing, a lot of the price of the clothes doesn't come from demand. It comes from the price of the gas used to move it from A to B and all the people involved moving it, and the price of the food to feed all the people who made it and sell it. Gas and food are hiding in all the inputs of clothes. There is a floor on the cost of clothes, it keeps rising, what exactly will increasing interest rates do to the rising (producer's) cost of clothes?
The reality is that as long as so much of oil/gas inflation exists and interest rates rise, something other things will HAVE to give. People will just have to be ok with a life of less abundance.
1. choice: The idea is that you can put your money in the bank and get some interest or you can spend it. So when interest rates go up, people will chose to spend less and save more. Obviously rates have to be higher than inflation which is now 10%, for this strategy to work, but at high enough rates, they will choose to save rather then spend. Less spending, demand falls, so prices should drop.
2. money supply: For the non-financial sector of the economy, money is created when households borrow from banks, and money is destroyed when loans are repaid. Increasing interest rates reduces loan growth and thus the money supply. A smaller money supply should lead to lower prices.
3. business investment: higher interest rates means that the cost of capital to firms goes up. They must earn a higher margin in order to service whatever debt they have at the higher rates, and investors can choose to invest in the business or buy a bond, and so the business has to earn a return at least as high as the bond. So higher interest rates means that ventures which would have been profitable at a lower rate are no longer profitable. So less business investment at higher rates.
Translates into, Less money for stock buybacks, less Yolo with stimy checks, left over money to yolo is also reduced == the market returns to mean. People feel less wealthy == slow purchases. Reduced purchases == Business struggle. Businesses lay people off == less demand. All of this == Less driving, less food.
Really very simple.
I don't think you are wrong intuitively. I am just trying to be a little more specific because get very vague about monetary policy and it leads to some bad assumptions.
Every mainstream economist agrees that rising interest rates increases unemployment.
Well you need human beings to go and make stuff like food and gas. That stuff is also already made as efficiently as possible. So supply is definitely, also, going to be reduced.
Because if you don't acknowledge the steps, you can't explain what is happening today. Rates are going up and unemployment isn't. The economy is complicated.
But probably more importantly the increased cost of borrowing hits businesses which are living on the edge and have been rolling over short term loans at low interest rates. When that debt service triples then those unprofitable businesses will start facing negative cash flow losses and can be pushed into insolvency.
For just one example, look at all the commercial real estate vacancies in downtown SF and Portland. Behind a lot of that will be very cheap financing which will go under when interest rates rise (and it is all reasonably short-term financing because it had to be in order to get the lowest interest rates and keep the businesses barely treading water -- so think of this as ARM mortgages for business).
So you have reduced demand for anything funded by loans, along with businesses at the margins going under because their cost of borrowing increases. You get layoffs from the businesses going under which will remove demand for goods. The reduced demands for goods then filters through the system producing more layoffs and more reduced demands for goods across every sector and the economy contracts into a recession.
All the Fed does is raise the cost of borrowing money which causes enough businesses on the edge of failure to fail that it pushes the economy into a recession--amplified by all the positive feedback loops in the economy.
Honestly don't know why this is such a mystery to everyone or why the question needs to be a "meme", it is pretty straightforwards. The only tricky part might be understanding why failures of businesses on the margins could lead to an economic collapse, but you'd think that with the audience of engineering-oriented people here that we'd collectively understand positive feedback loops amplifying small changes into big ones.
Oh there's also purely subjective psychological positive feedback loops as well. Layoffs at FAANGs right now (or whatever they're called these days) is more due to forward expectations and those businesses getting a bit more runway for the recession. But by doing that they're helping to create the very recession that they're getting prepared for. Similarly in the middle of a recession businesses cut jobs and curb spending because they're in a recession, making the recession worse.
Yes, but prices are not demand, they are supply and demand. What if you shut down the parts of the economy that make food and gas?
For example, how do fed interest rates shut down the parts of Saudi's economy that makes oil?
Anyway, in your explanation, you do not use the words "food" or "gas" which is how the "CPI" is calculated.
> Honestly don't know why this is such a mystery to everyone or why the question needs to be a "meme", it is pretty straightforwards.
Using the words in the question to answer the question is "straightforwards."
I didn't mention the words "food" or "gas"[*] because I thought it was obvious, this stuff is really, really basic economics. The economy is all connected, so someone's contraction in spending is another market participant's contraction in demand--and as businesses see a contraction in their demand they adjust to contract their own spending.
When it comes to food, people contract their spending by starting to make coffee at home or just buy starbucks less often as a splurge rather than a daily thing, so that contracts revenue for starbucks, that leads to layoffs, which leads to less consumer spending, etc. The prices of staples don't usually drop as much because people still need to eat, but with reduced energy and transportation costs the supermarkets can reduce the cost of milk to try to attract customers.
[*] Actually on re-reading I did mention food and gas: "The reduced demands for goods then filters through the system producing more layoffs and more reduced demands for goods across every sector and the economy contracts into a recession." And "every sector" really means literally every sector of the economy--including "food and gas".
Their explanation was about as simple as you can get.
> Yes, but prices are not demand, they are supply and demand. What if you shut down the parts of the economy that make food and gas?
Think this through and remember that food and fuel are must haves. There will always be demand, even at high prices. Just less of it. Which is what the point is.
Prices going down (Deflation) in a modern economy is very very very bad even if it's for Food and Gas. Since WW2 our economic system has been based on prices going up because that means people are producing goods to make money to spend it on goods. The real goal of these interest rate is to slow the rate of price increase because now there is less money available to borrow / print into the system. People / Businesses will now use debt less often to leverage their purchases which will slow down the economy. If prices increase too quickly the system burns itself alive. If prices lower it decays and dies.
So to answer your question prices will continue to rise because inflation will remain positive, however the rate of it will be lower.
Also note that we are in a similar situation as when Nixon propped up the economy before an election in 1972. It took a while for his policies to backfire. Unemployment rate was 3.5% when Nixon was elected and doubled by 1974.
The current dominating party in the US is not taking as many extreme measures as Nixon of course, but for me I want to see where the economy stands after the election dust has settled.
It's not the election, it's Black Friday that will be the bellweather, I think. If inflation is still ongoing, discounts will be minimal. If the economy is going south, sales will be tepid. Nobody is ready to lower prices permanently, but temporarily? Massive discounts are the traditional way for retailers to lower prices in times of uncertainty. The rise of the dollar and the inflation of the past year will give retailers lots of room for discounts, so I expect to see them liberally applied. And with unemployment so low and low-income wages rising so quickly, I expect to see record retail spending this month.
This Black Friday is unlikely to be any kind of bellweather. It normally takes 6-12 months after rate hikes stop for them to be felt in the broader market. Next Black Friday might be a bellweather, but I expect that we'll already be in it by then.
The Fed can do that be damaging demand by damaging the labor market and reducing the value of assets (which also damages spending power ultimately in numerous ways).
There should be a lot more consideration given to increasing and improving on the production side right now, however the US is not nearly so skilled at that these days (whether industrially or policy wise). If you walk into your typical CVS or Walgreens and look at their empty baby formula section, it tells all. Supply chains are still a mess in the US.
The US knows how to drill for oil and frack. It would help curb inflation and help Europe deal with Russia.
What is the common sense explanation for how increasing interest rates reduce the extend of price increases of food and gas?
We have differing definition of common sense.
It will bring down housing, which is 1/3 of the CPI by weight and helps get the Fed's inflation metrics down. (Just as an example, it won't make as much sense to leverage up and buy 5 Airbnb's at higher interest rates.)
How does it reduce demand for gas?
This is what I mean.
Increasing interest rates increases the temptation to lend money instead of spending.
Why would people cut spending on food and gas? They need both to survive. That's what the CPI is made of.
There is some non-critical spending to cut, Feds rely on that.
This is complex.
Lower interest rates overall increase home prices, because people buy the biggest home they can afford on a monthly payment.
There are many kinds of cars. Some are cheap and some are expensive.
Anyway, how do interest rates make things like food and gas more expensive and out of reach? Those don't require financing. They're hugely impactful on inflation. You can be the Fed, and pretend there's a "core" CPI, but the people who make your clothes and cars need food and gas, your clothes are made with a lot of gasoline directly, via shipping and manufacturing, etc., so it is sort of a fiction that there is this non-food-and-gas CPI.
It reduces demand - in the modern world the prices are disconnected from cost of production - instead reflect the demand for that product - how much can it be sold for
Does it suck money out of the system? Here's a common sense example: Raising interest rates caused assets like stocks and bonds to decline in price. People sell these equities and now have cash they are willing to spend on more shit, specifically what is in the CPI. So the opposite can also happen.
Every time a loan is agreed, the value of the ${NATIONAL_CURRENCY} is diluted by a tiny amount. And that tiny dilution is amplified through the economy and has a proportionally larger effect on the price of end-user items which inflate to compensate.
Increasing interest rates is not a lever that directly affects things measured by the CPI, but the idea is that the effects will ripple through the economy and reduce the delta-v of their prices at the end of a very complicated series of gears and pulleys.
It's a bit like trying to refloat a grounded ship by subtly nudging the Moon's orbit to modify the tides.
This is true. It does not tell me how the money created through borrowing between 0.75% rates and 4.00% rates was used to buy food and gas though.
That borrowed money was overwhelming actually used to buy equities, which the fed is obviously impacting very effectively, and not food and gas, even indirectly.
Then it should be obvious why the Fed is doing a terrible job.
This is true, this is at least appealing to common sense. But I don't see how that excess cash was going into spending more on food and gas.
If I run a supermarket and raise prices, and people like lettuce, if they keep buying the lettuce, because $3.75 lettuce is still worth it compared to $2.00 lettuce, well, CPI can increase a lot, and demand appears to be inelastic, and interest rate increases did nothing to reverse CPI.
The simplistic version is one idea of the cause of inflation is there's too much demand for all goods as a whole in the economy because there's too much money floating around causing demand to push higher on the demand/supply curve because it's more expensive to produce more of something past a certain point. Making it harder to get loans decreases the money flowing in for some expenditures so there's less expansion in areas like hiring (which when we're near full employment like now usually means having to raise wages pushing costs up and injecting money into the more general market). Thus by increasing the cost of expansion you slow it down and cool the labor market and maybe even cause it to contract.
In the end it boils down to getting more people out of work so they can't buy as much and are willing to accept lower wages meaning it costs less to produce so you might meet the increased demand curve in the middle. It's an incredibly shaky way to try to run the economy but the government has limited knobs to turn and ideally it's easier to target relief at people put out of work because of this than it is to aid the entire population generally.
That's one theory I've heard explained at least. It's incredibly callous to me though because it depends on just putting people out of work and our safety nets in the US are extremely weak meaning you wind up with the fact that a 1 percentage point increase in the unemployment number is associated with a 1-1.6& increase in suicide rates. [0]
[0] https://www.healthaffairs.org/do/10.1377/hpb20220302.274862/....