Inflation

y0ssar1an22

i've been curios about this for a while and still cant figure it out....

inflation is bad so to curb it the banks will increase interest rates.

i just dont get this premise at all. essentially, you have less to spend cos of higher interest rates so prices will go down. surely off the back of this, banks make more money via the higher interest rates?

could you not increase the lower level of tax by (say) .05% and reach the same goal? and the government get the extra rather than the banks?

Ubbquittious

https://www.boards.ie/discussion/2058276097/inflation

The government would then have to destroy the money it got in or at least hold onto it for a long time. Governments could in theory hold onto money but in practice they are extremely bad at it.

So instead they let private banks for the most part control the creation and destruction of money. Then the government panders to said private banks because they too are then at the mercy of the system.

y0ssar1an22

https://www.boards.ie/discussion/comment/120005753#Comment_120005753

thats makes no sense to me at all.

just my question....why do we tackle inflation by giving banks more money (via increased interest rates).

it cant make sense

Leg End Reject

https://www.boards.ie/discussion/comment/120006023#Comment_120006023

My very simplistic answer is that it takes money out of the economy, reduces spending power, demand and prices lower as a result - cost and demand.

I've no idea why banks raise interest rates to facilitate this though.

Geuze

https://www.boards.ie/discussion/2058276097/inflation

Typically, high inflation is caused by a booming economy.

In that case, there are two typical responses.

CFP = contractional fiscal policy = slow down the economy vis tax increases and Govt spending cuts/slowdowns

CMP = contractionary monetary policy = the Central Bank increase interest rates

CFP is political, and much more difficult to implement.

As the Central Bank are usually independent of the Govt, then they can implement CMP even though it may cause a recession.

(by the way, one issue is the current inflation is not really caused by a booming economy, so is CMP the appropriate response?)

Geuze

https://www.boards.ie/discussion/comment/120006023#Comment_120006023

When the central bank increases interest rates, the aim is not to increase commercial bank profits. That is a side effect.

The aim is to slow down expenditure in the economy.

Geuze

https://www.boards.ie/discussion/2058276097/inflation

You could.

But a Govt would not be popular, or re-elected, if they used CFP to cool down inflation.

Indeed, our Govt is expanding expenditure, by giving everybody 800 off elec bills, as well as a load more one-off temporary measures to deal with the cost of living.

dotsman

https://www.boards.ie/discussion/comment/120005753#Comment_120005753

This so wrong. It is not just that you don't understand how it works, but you've no doubt seen a 5-minute youtube clip, so now think you know everything about it.

We don't "let private banks control the creation and destruction of money". The ECB sets the rates (and also via asset purchase programs etc) in a bid to control the flow of money ensuring a steady inflation rate of close to 2% which is their mandate.

https://www.boards.ie/discussion/2058276097/inflation

The idea regarding interest rates is simple:

When an economy is booming, people and businesses think it will last forever and things will keep getting better. Thus, they borrow more and more and spend more and more. The result is demand exceeds supply and prices go up (inflation). By raising interest rates, they discourage borrowing, while also encouraging saving (hoping people will "make hay while the sunshine" etc).

When an economy is falling, and prices falling due to decreased demand, to boost economic activity, they decrease rates to make borrowing easier and more appealing, while discouraging saving, in the hope that the money will start to flow again and the economy picks up.

The problem with the situation we have today is that the rapid rise in inflation is down to the perfect storm of 3 things:

1. Inflation began to rise during the pandemic as supply-chain issues resulted in shortages of certain goods. Thankfully, many people developed a savings habit during the pandemic, so it was only really noticeable at the time in certain specific in-demand, pandemic related goods (think monitors, bicycles, GPUs, video game consoles etc). However, after the pandemic "ended" in the West, people began increasing their spending across a much wider basket of goods, thinking things were back to normal, when in many cases, there are still ongoing covid-related supply-chain issues in Asia causing shortages.
2. The ECB (along with central banks all over the world) flooded the market with cheap money during covid to allow governments such as our own to spend stupid money on assistance schemes and PUP etc while also shutting down a huge part of the economy for 2 years. If you flood an economy with vast quantities of unearned money - you get massive inflation.
3. The war in Ukraine has led to critical shortages of certain essential goods such as oil, gas and wheat etc, which in turn feeds into so much of the wider economy. Thus, the cost of energy has rocketed, but so too has the many, many goods that require energy to be produced and subsequently transported from factories to other factories to warehouses to distribution centres to shops and finally to your kitchen/living room.

However, raising rates really only tackles the first 2 to some degree, but does nothing to combat the 3rd one. The problem is that, with the ECB (and other Central Banks) raising rates is the only weapon in their arsenal, so "when all you have is a hammer, every problem looks like a nail".

As mentioned above, increasing tax would not work, as governments are weak and would end up spending it under pressure from unions etc rather than destroying it (or saving it for the next recession etc) which is what is required

Tonesjones

All sorts of companies putting up the prices of their products as their suppliers have upper their charges as the price of materials that the suppliers purchase have also risen.

However many of the companies (like the one I work for) have not given wage increases to staff.

Surely if less people can afford to buy these products as their wages have in real terms dropped then these companies end up going out of business or at least don't return a profit which in turn increases staff lay offs.

astrofool

https://www.boards.ie/discussion/comment/120006330#Comment_120006330

Depends, the costs have gone up due to to constrained supply of the material, then the company slowing down production due to weaker sales also reduces demand for the material causing its price to drop.

The company then has to work out how to remain profitable with reduced sales.

Wanderer78

https://www.boards.ie/discussion/2058276097/inflation

this is whats called supply side lead inflation, central banks do not have any tools in their toolbox to deal with it, only a dreadfully blunt non working tool called interest rates, raising rates is only squeezing the fcuk out of global credit and debt markets, expect something to break in global financial markets in 23....

taxation is only a part of recirculating money, it is not creating money, increasing taxes actually removes money from circulation of the economy, but of course this money can be redirected back into the economy, increasing taxes on lower earners is beyond stupid for many reasons, one being, most income of lower earners is spent back into the economy, increasing their taxes reduces their spending power, and subsequently reduces the velocity of the money supply, the turn over of money in the economy...

increasing rates is decreasing the velocity of the money supply, so less and less transactions are occurring during this period, increasing the likelihood of business failures, hence rising unemployment....

what we should be doing is in fact increasing the money supply, but making sure it makes its way into our economies, and not towards the global financial markets, which is commonly what happens, as was the case with polices such as qe etc, covid payments such as pup were a perfect example of pushing money directly into the economy during covid, and it worked, go figure.....

happy christmas!

Wanderer78

https://www.boards.ie/discussion/comment/120006253#Comment_120006253

2017_04_money_creation_process.pdf

Money creation in the modern.pdf

WHAT IS MONEY.pdf

the majority of the global money supply is in fact created by private sector financial intuitions, we call them banks, as banks create money when creating loans, this method is sometimes referred to as 'double entry book keeping, and this has been confirmed by respected institutions, including some central banks, papers included.....

dxhound2005

Just as money is "created" when a loan is given out, it is "destroyed" when that loan is repaid.

Jim2007

https://www.boards.ie/discussion/comment/120006023#Comment_120006023

Well done, at least you are one up on that nonsense!

It’s not about the banks, it’s about reducing the total spend and we don’t just use interest rates to do it. Taxation just changes who makes the spend, but interest rates make it more expensive for everyone including governments, that is why having an independent central bank is so important.

It’s also not as simple as banks make more profits either because their cost goes up as well since you will expect to be paid higher deposit rates and various other financial products will have higher payouts as well. Take fixed mortgage rates, depending on who rates go they will make excess gains on some and losses on others. Taken over an entire cycle it probably won’t make such a big difference.

Timing belt

https://www.boards.ie/discussion/comment/120006568#Comment_120006568

Money creation is not just generated by private banks it’s generated from any form of new debt including government debt.

Money destruction happens when debt is repaid. Central banks increase rates because it reduces the amount of new debt and at the same time encourages the repayment of existing debt and as a result reduces the money in circulation which in turn reduces inflation.

QE or as people like to call it money printing is just a swap of long term debt to short term. It’s not the creation of new debt if it is applied to debt that is already in circulation. This is why QE failed to generate cpi inflation in the wider economy up to 2019. It was only when the government started issuing new debt and accompanied it with fiscal spending did the money get out into the wider economy and start generating cpi inflation.

The measure of velocity of money has become less relevant since 2008 as the money supply of short term money has increased (while long term money decreased). Likewise using the old measures of M1 and M2 money to calculate velocity of money was distorted by the reclassification of savings deposits during the period resulting in a lower velocity of money.

taxation as a tool to slow inflation is ineffective unless the government uses this additional income to repay debt (money destruction) if the use it for any fiscal spending it just recycles money and has zero impact on inflation. The use of taxation is more about a reallocated of money in the economy and if used correctly can help protect people on a fixed income but if not used correctly will generate inflation if to much money is reallocated to people on fixed income as they are more likely to spend.

in regards to push inflation you are correct that raising rates does little to control this but what it does do is address any secondary inflation that is generated as people demand more money for working to pay for cost of living increases.

Oil/ Gas are the big drivers of inflation and even if these fall back to pre pandemic and pre war levels it will take the best part of a year for the high prices to wash through economy whilst increasing the likelihood of secondary inflation and hence why the central banks need to take a harsh stance to prevent this from happening. If oil and gas prices consistently stayed low then you would see central banks cutting rates this time next year because the high energy prices would have been washed out of the system and the economy would start to enter a deflationary period.

dxhound2005

Even though interest rates on borrowing are increasing, there is not much indication that interest rates on deposits are going to increase very much. All that has happened so far is that banks have stopped negative rates for large amounts, and gone back to zero. Banks, Credit Unions and the government in the form of the NTMA have been trying for years to deter new deposits.

Despite that they are stuffed to the gills with deposits that they can't lend out, following years of record deposits coming in. Even though people are losing money due to inflation, they seem to want the security of guaranteed deposits. This is a feature of the post crash years, when people found out that their house is not necessarily a money making machine.

Wanderer78

https://www.boards.ie/discussion/comment/120006641#Comment_120006641

...and loans are regularly rolled long term within the corporate sectors, hence why private debt has been significantly rising in recent decades....

Timing belt

https://www.boards.ie/discussion/comment/120006752#Comment_120006752

Banks are awash with liquidity so don’t need to pay for funding. This will change in time especially when the ECB start QT and as a result reduce liquidity in the financial sector. The first sign that banks need liquidity will be where banks start to offer attractive rates for notice accounts of 30+ days or money market deposits. Personally I think we are at least 6 months off this situation because there is that much liquidity out there

Danzy

Taxing to reduce inflation would take too long and not cut back on excess capital borrowing or creation.

Making it interest rates based changes things nearly immediately.

As it is the ECB are forecasting 7% next year, 4.5% in 24 and 3ish in 25. That's still very brutal and effectively finishes a part-time business I have as inputs inflation in the sector has been about 30% for me, with cost cutting and corner cutting. Product at end is barely keeping up with inflation as is and expected to fall in price.

Timing belt

https://www.boards.ie/discussion/comment/120006784#Comment_120006784

And governments don’t roll their debt!!!

Ubbquittious

https://www.boards.ie/discussion/comment/120006253#Comment_120006253

Yet there is ample evidence that private banks do control the supply of money. They are dependent on a steady supply of customers taking out loans in order to do it but they choose how many they'll turn away.

The private bank also cannot go wrong. The government will come along and bail them out if they overindulged in creating magic money on the back of issuing loans.

dxhound2005

Since they do not exist except for the steady supply of customers, any bank bailout is of the customers who default. By other customers who pay their own way, and a bit more for the defaulters. And by taxpayers who government depend on for "their" money. And if they borrow other money, it is the taxpayers who have to pay it back ultimately.

Timing belt

https://www.boards.ie/discussion/comment/120007537#Comment_120007537

Not necessarily true anymore as banks are required to issue convertible notes that would recapitalise the bank instead of the government bailing it out…this is part of the regulatory changes since ‘08

dxhound2005

The deposit guarantee scheme is funded by themselves as well. So no taxpayer/government bailout for depositors in future. The government has the function of approving which institutions can offer the guarantee, and unlike State Savings which is an unlimited guarantee, it has a limit of €100K per account.

The reverting back to the old rules about mortgage lending, should diminish the need to bail out borrowers in comparison to the immediate post Tiger era. And no future recession should feature negative equity, just as none before the Tiger ever did. But the big constraint on institutions is the courts not enforcing repossessions, leaving other customers to pick up the tab for the defaulters from the Tiger era.

riclad

we are in a new era, one of the causes of inflation is high energy prices ,the war in ukraine, also we have the supply chain crisis, certain goods are hard to buy , it turns out making everything in china is not a good idea ,when factorys close due to lockdown.

factorys and restaurants use alot of power they have to raise prices when the price of gas ,electricity go,s up

dotsman

https://www.boards.ie/discussion/comment/120006568#Comment_120006568

https://www.boards.ie/discussion/comment/120007462#Comment_120007462

Did you read the documents you attached? Did you understand them?

To quote one of them:

The amount of money created in the economy ultimately depends on the monetary policy of the central bank. In normal times, this is carried out by setting interest rates. The central bank can also affect the amount of money directly through purchasing assets or ‘quantitative easing’.

This is the point. While private banks perform the transactions, the control is with the Central Bank. Individual private banks don't dictate to the market, they simply ride the wave.