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What Does The Inflation Rate Indicate?

Why would the interest rate increase now?

  • I am hearing a lot of news about the potential for interest rate hike in USA. For nearly 5 years the interest rates have been kept extremely low. Now there is talk about interest rate hike, raise in minimum wages, etc. Together these seem to indicate that overall cost of everything will raise almost fuelling the inflation fires by itself. Why would someone want to flame the fires from both sides (unless it is some game of sorts)? And Why now?

  • Answer:

    First things first, hiking interest rate has a negative effect on inflation and growth. Simply put, when a central bank decides to hike interest rate (through fed funds target rate, reverse repo rate or the new term deposit facility by the Fed), the net effect is that there is a decrease in money supply and increased cost for banks to lend money - banks transfer this increased cost to their customers- business have to cut their production as they need to borrow money of production & individuals spend less as they too have to borrow at higher rates and less disposable income. All this leads to a general dampening in economy and hence lower inflation.   Second part of question which is specific to US- the news of potential rate hike sometime during the middle of next year has to do with inflation picking up in the recent months. CPI in May rose by more than two percent on year on year basis and PCE (Fed follows this index) is expected to breach the two percent target soon as well. The timing of a rate hike is crucial and the Fed governor Yellen has been consistently dovish and supportive of loose monetary policy at least for a some more time as she and the rest of Fed believes the growth in the economy is still not self sustainable- at some point they will need to hike the interest rates to curb inflation. In a nutshell, the risk of not raising interest rate is unwarranted inflation, but doing it too soon may curtail the growth in the economy as it is still recovering. The timing will be crucial indeed!

Shailendra Kumar Singh at Quora Visit the source

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I just guess you refer to the situation in US and UK. Because economy and job market are getting better. No need for more additional stimulus. Time to worry about inflation. See you edited your question. Rate hike won't raise the inflation. Actually inflation is key factor that Fed would raise rate.

Alice Qi

Thanks Gopalswamy. I was interested in the situation in USA right now. After many years of low interest rates when the economy seems to have been limping along for better state, why would the government want to increase interest rates.

Murali Krishnan

The monetary policy tool to control inflation is interest rate. In India at this point of time it is huge increase in money supply which is the cause of inflation and hence monetary policy tool MAY work

Gopalswamy Bhaskar

USA is close to a recession and to come out of it, more money (fiscal deficits) have to be introduced. This requires interest rates to increase (for bonds to be more attractive). Inflation stays around 5%. The GDP increases more and people are better off. GDP always beats inflation.

Partha Shakkottai

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