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Chapter 21, Part II. The Power of Interest Rates. Page 2

Discussion in 'Complete Trading Education- Forex Military School' started by Sive Morten, Dec 22, 2013.

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  1. Sive Morten

    Sive Morten Special Consultant to the FPA

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    To hold down inflation, a central bank usually starts a so-called tightening policy, when it starts to increase interest rates. This is a long-term process, since a Central Bank also should track the changes in economy growth pace, unemployment, sales etc, and inflation of course. Changes rate a bit – look at what happens. If more is needed, change again, etc.

    Pipruit:
    Ok, I understand that to reduce and hold inflation, a Central Bank has to increase the interest rate, but I do not see logic here. What correlation is there between economic growth, interest rates and inflation?​


    Commander in Pips: Oh, right. Listen. Imagine that you have your own business. Let’s assume that you produce something, no matter what particularly. When is better to increase your business, when rates are low or high?


    Pipruit: Low, I suppose, since to develop any business, to increase production, I need to borrow money to pay operating and capital expenses.​


    Commander in Pips: Absolutely. So, when interest rates are low, the real economy starts to rise, since every company wants to use this condition to borrow money and invest these funds in growth. Since companies actively start to borrow – this is also good period of times for banks. The public also starts to borrow since low interest makes loans cheap. This leads to capital spending, personal spending, growth of retail, capital sales – to growth in whole economy.


    Pipruit: So, that’s excellent! Let it grow! Why should Central Bank interrupt that?​


    Commander in Pips: This is not so simple. Growth in an economy leads to a significant increase in demand for raw materials and commodities. If demand is growing, then price will grow also. Growth in price on raw materials and commodities increases producers’ operational expenses. Hence it increases the final cost of goods for consumers. Now they can buy less for the same amount of money. That’s inflation.
     
    #1 Sive Morten, Dec 22, 2013
    Lasted edited by : Sep 24, 2016
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