[I274]Inflation And Interest Rate

Inflation makes tomorrow's money potentially worth less than today's, that makes borrowing more appealing to borrowers, but lending less attractive to lenders in order to compensate, lenders increase interest rates, since among other items, they too know that the dollars they will be re-paid next month are potentially worth less than the ones they loan out today.

Therefore, a vicious cycle is established, as prices increase more people including companies, discover themselves needing to borrow more if they are to buy the items they require cars, home improvements, business equipment etc this tends to raise interest rates even further, since there is now more demand for borrowed cash, more demand given a set supply tends to increase prices, in this situation the price (this is the interest paid) is the total price of borrowed money.

Since inflation is principally caused via governments whether through high borrowing themselves or deficit spending or real printing of more currency or issuing more credit, there's little an individual can do to change the method, all one can do as a citizen is recognize the reasons and advocate sound policies.

However, as a borrower there's much one can and had better do when considering the problem, after all governments don't continually increase inflation, if they did as occurred in the late 1970s, for instance interest rates would finally reach a level where there are loud demands to do something urgently, when they do something it invariably means closing down the spigot this is reversing or at least slowing the items listed above.

Those actions have a definite impact on everyone looking to borrow money, just as the inflation did, that deflation may also lower rates encouraging more borrowing, however it also causes cash borrowed today to be worth less than they would be tomorrow, hence you are repaying a loan with money that are potentially worth more tomorrow if you kept them (by saving or investing) than they are today.

Therefore, when you look into borrowing you have to try to make a guess, just as the banks do about which way inflationary or deflationary pressures are most likely to go, that is a hard job for even professional economists, thus how may a layman be expected to do that with any rationality? While there is no sure method there are a few indicators that are available to everyone, it used to be that gold and silver were realistic indicators, but that's no longer correct since the dollar is no longer related to any hard commodity, nonetheless there are one or two that can be beneficial.

Two inflation indicators to be considered.

Since oil is a very common commodity that is tied to a large percentage of production costs of other items, as the price of oil increases inflation is most likely to heat up a little, hence look at the price of oil options to see whether prices are expected to be higher or reduced in the future.

The price of bond options going up is also an indicator, in this case it hints that professional dollar managers are betting interest rates will change sharply over the coming years, the relationship is very complex and borrowers would do better to consult a specialist.

Please keep in mind that a dollar today is a measure of the cost of todays goods and services, just as a dollar tomorrow is a measure of that cost tomorrow, but when borrowing cash you're buying dollars today to spend today, however will pay them back in the future, how much these dollars are worth when you pay these back is a measure of what that loan will in reality cost you.