The higher the interest rates go, the higher the inflation, the greater demand for credit, the higher the rates go to try and quash that increase in demand, the higher the inflation goes, the higher the… A classic inflationary spiral.
You got it wrong at the point where higher interest rates increase demand for credit. It is the other way around: when interest rates are high, fewer people want to go into debt. On the contrary, not only fewer credit products are purchased, but also people try to repay their existing debts faster.
So while there is a temporary increase in mortgage repayments of existing mortgages, fewer new mortgages are signed and the demand for other products and services is also decreased because the money people spend in repaying debt is money they are not spending elsewhere.
Huh? Like I said, inflation increases demand for credit. Debt shrinks under inflation, so it becomes more compelling to take on debt in an inflationary environment.
Sorry, I must have misread it. I agree that nominal demand for credit increases under an inflationary environment, but only under the condition that interest rates stay constant. Which they don’t, because central banks intervene. I hope we agree so far.
That is why interest rates rise alongside inflation
As I understand it, the interest rates of e.g. mortgages are (rather) indirectly set via the overnight lending rate of the BoC. In other words, mortgages rise because the BoC rated increased its rates. And that in turn happens because the BoC knows that increasing the cost of money lowers demand.
The effect of this intervention means that inflation-adjusted demand for credit today is lower than it was before the rate hikes started.
Same reason why, all else equal, the cost of bread increases when demand for bread increases. Basic supply and demand.
Credit is not a free market thanks to central banks. That is why they were created in the first place.
But if those interest costs are responsible for driving inflation, then you can find yourself in an interesting feedback loop where taking on debt remains compelling no matter how high rates go.
In theory, yes, that could happen. In practice, high enough interest rates asphixiate demand: people have less amount of money to spend on anything other than servicing their debt, causing unprofitable businesses to go under due to lower demand and their inability to access cheap credit, forcing businesses lay off their staff, which means that people stop being able to pay their mortgages, leading to foreclosures, and then a self-reinforcing slump of home prices.
This has happened many times before and it is happening now.
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You got it wrong at the point where higher interest rates increase demand for credit. It is the other way around: when interest rates are high, fewer people want to go into debt. On the contrary, not only fewer credit products are purchased, but also people try to repay their existing debts faster.
So while there is a temporary increase in mortgage repayments of existing mortgages, fewer new mortgages are signed and the demand for other products and services is also decreased because the money people spend in repaying debt is money they are not spending elsewhere.
I hope it makes sense.
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Sorry, I must have misread it. I agree that nominal demand for credit increases under an inflationary environment, but only under the condition that interest rates stay constant. Which they don’t, because central banks intervene. I hope we agree so far.
As I understand it, the interest rates of e.g. mortgages are (rather) indirectly set via the overnight lending rate of the BoC. In other words, mortgages rise because the BoC rated increased its rates. And that in turn happens because the BoC knows that increasing the cost of money lowers demand.
The effect of this intervention means that inflation-adjusted demand for credit today is lower than it was before the rate hikes started.
Credit is not a free market thanks to central banks. That is why they were created in the first place.
In theory, yes, that could happen. In practice, high enough interest rates asphixiate demand: people have less amount of money to spend on anything other than servicing their debt, causing unprofitable businesses to go under due to lower demand and their inability to access cheap credit, forcing businesses lay off their staff, which means that people stop being able to pay their mortgages, leading to foreclosures, and then a self-reinforcing slump of home prices.
This has happened many times before and it is happening now.
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Hey, I’ll be happy to maintain a civil conversation but I won’t entertain rudeness. Have a great day!
deleted by creator