Let's start with the meaning of inflation and interest. Inflation is the diminishing value of assets: prices are rising on average. The opposite of inflation is deflation, where assets increase in value and prices fall on average. Interest is the payment for making assets available. The interest we are considering here is the refinancing rate set by the central bank. It is important to consider the difference in the nature of inflation and interest. Inflation is a given, while interest is an instrument (of the central bank). In other words, inflation is an external variable, and interest an internal variable. Because inflation benefits no one, the central bank tries to control inflation with the interest-rate instrument. Inflation decreases with higher interest rates. This has two causes. First, there is the effect on the exchange rate of corresponding currencies. After all, wealth investors will prefer to do so in currencies that yield the highest interest, which increases the demand for that currency, which increases the exchange rate (price) of the currency, which makes imports cheaper, which decreases inflation. there is the effect on the money supply (M). When interest rates rise, more is saved, reducing the amount of money in circulation. Here we can use the Fisher equation to reason about the price arrow.
The Fisher equation is as follows: M v = Y p The meaning of the variables is: M = money supply in circulation, v = turnover rate, Y = national product, p = price level. When M is decreased, another variable must change to keep the Fisher equation valid. The turnover speed and the national product will not change (just). The price level is the variable that will change. The Fisher comparison shows that the only possibility remains a decrease in the price level, with other advantages: money becomes more valuable, so there is a decrease in inflation. The foregoing has shown that inflation will go hand in hand with higher interest rates. Now we can still look at the effect of rising interest rates on the prices of shares and bonds. If interest rates rise, corporate debt will become more expensive. Moreover, consumption is declining because relatively more is saved. The two factors are unfavorable for companies. This will cause stock prices to fall. The price of bonds is determined by the nominal interest rate of the bonds and the market interest rate. When market interest rates rise, the nominal interest rate of the bonds will be relatively lower. As a result, the real interest rate of the bonds becomes lower and the price of bonds falls, in such a way that the real interest becomes equal to the market interest rate.
0 Comments
Leave a Reply. |
Thank you for choosing to make a difference through your donation. We appreciate your support.
This website uses marketing and tracking technologies. Opting out of this will opt you out of all cookies, except for those needed to run the website. Note that some products may not work as well without tracking cookies. Opt Out of CookiesCategories
All
Archives
April 2024
|