Can anyone give me a dummy's guide to inflation and interest rates...?

Question

And what determines how they are adjusted, the effects etc..is it a predictable course, eg a cycle every few years? Assume I have no knowledge. Thanks

Answer 1

Inflation is nearly entirely caused by changes in the money supply, in addition to what people think those changes are going to be.

If there is too much money floating around, it devalues the currency and makes your dollar worth less -- very simple supply & demand.

So how do you stop inflation? You reduce the money supply. The Fed doesn't directly change the interest rate. They will SELL securities that they have on the open market; and will collect dollars for it.

This leave less dollars in circulation for banks to lend, so the money is more valuable -- and the interest rate is higher.

Answer 2

The Moneterist camp state that inflation can be controled by contoling the money supply. Thatcher attempted to implement the ideas of the main moneterist champion - Friedman.

Damn, dummys guide.

OK The cost of living will rise as goods and services prices rise. Inflation is a measure of this rise in the cost of living. During the late 70s inflation was very high. This meant that your savings were erroded because you could buy less with the same money. In Germany during the 30s, with the Rhure industry strike, the German Govt printed money to support the strikers, creating super inflation (Wages re-negotiated daily and wheel barrow needed to buy loaf of bread).

Back to the moneterists. To control inflation, make sure that there is less money in the economy to spend, thereofore prices won't rise.

High interest rates mean that, rather than investing money in property, business, you can make just as much putting money in the bank. This is why the Bank of England raises and lowers interest rates - to control the money supply and therefore keep a check on inflation (There was method in the madness when Labour gave control of interest to BofE (It could spend with passion and not have to worry about upsetting voters with high interest rates).

So, the higher the interest, the less money in the economy, the lower the inflation rate.

Luck.

Answer 3

Well it is a long topic and I suggest you read the links which I have provided.

Let me explain in short. Inflation occurs when the money supply is more in the economy. So the value of money decreases and that of commodities increases. Because people have more money and they want to spend it so the demand for commodities and services increases, thus beefing up their price.

To counter act upon this the Govt. increases the interest rate and takes out money from the economy as people start saving for more interest and pump less money in the market(e.g. stock market).
This obviously makes the economic growth slower but prevents it from overheating and in turn going into economic depression.
To calculate the exact rise or fall in interest rates the Govt. monitors the Supply and Demand curves very closely.

Answer 4

Inflation is not adjusted - it happens for a number of reasons. Inflation takes place when prices rise. This could be a global issue, like the price of oil, or it could be local, like the price of property in desirable neighbourhoods.

Interest is one way which the Bank of England tries to control inflation. If the interest rate rises, people will not borrow as much money because the repayments will cost more. This will tend to push prices downwards and slow the economy.

Low interest rates are nice for people who are in debt, and high interest rates benefit lenders, such as banks, building societies, and of course individuals with savings accounts!

Interest rate increases in one country tend to push the value of that country's currency up in value compared to those of other countries. The recent rise in UK interest rates means that you will get more US dollars or Euros for your pounds if you exchange them.