Increases in interest rates will only lead to further economic devastation

Jul 25, 2022 | Economic Collapse

The Federal Reserve’s efforts to keep the economy and prices stable are a big reason why consumer prices have been going up faster than usual lately. People usually think that the central bank’s job is to encourage both steady economic growth and stable prices. The economy is seen as a spaceship that sometimes slips from being stable to being unstable.

So the theory goes, that when economic activity slows down and falls below the path of stability, the central bank should give the economy a boost by lowering interest rates and increasing the money supply. This will get the economy back on the path of stable growth.

When the economy is “too strong,” on the other hand, the central bank should “cool off” the economy by making money tighter to keep it from “overheating.” This means putting the economy back on a path of stable growth and prices by raising interest rates and cutting money injections.

Consumer Price Index (CPI) increases are blamed on supply shocks caused by the plandemic and the Ukraine-Russia war, according to the government and the Fed. So, the Fed has tried to slow down the demand for goods and services by raising interest rates to match the lower supply.

Most people think that rising prices are caused by inflation and that prices will go down if there is less demand for goods and services because interest rates are raised.

But the main reason prices go up is because the money supply goes up. Keep in mind that the price of a good is how much money was paid for it. So, if everything else stays the same and the money supply goes up, it means that paying more money for goods causes prices to go up.

Once we agree with this point, we are likely to think that monetary inflation is the reason why prices are going up in general. Now, as a general rule, prices tend to go up when the amount of money goes up. But it is possible that prices won’t go up if the supply of goods grows at the same rate as the supply of money.

Once we agree that inflation is caused by an increase in the money supply, we can say that the inflation rate will always be the same as the growth rate of the money supply. This is true even if prices go up. Note that when the money supply goes up, the people who make money get less of it and the people who hold the new money get more. This diversion hurts the process of making money, which hurts economic growth and people’s well-being. On the other hand, when the money supply goes down, there is less wealth diversion, which makes it easier for people to make money and improves their well-being.

To make wealth creation stronger, all of the money leaks caused by the Fed’s asset buying must be closed. When the Fed buys an asset, for example, it pays for it with money made out of “thin air.” If the asset comes from a source other than a bank, this will almost immediately raise the amount of money in circulation. Once the Fed “prints” more money, a bigger government budget deficit will also cause the money supply to rise.

Once all the ways that money can be made are closed off, the flow of money will stop. When wealth creators have more money at their disposal, they are more likely to add to the pool of money, which sets the stage for real economic growth.

This goes against a tighter interest rate policy, which will hurt not only bubble activities but also real businesses that make money.

A tighter interest rate stance, like a loose monetary stance, changes the signals that consumers send about interest rates because it causes resources to be used in the wrong way and slows real economic growth. So, rising interest rates to stop price increases also hurts bubbles and other things that make money.

This point could be made clearer with the help of the next example. Think about a parasite that attacks the body and makes people sick. The parasite can also cause body pain and other symptoms. The problem can only be fixed by getting rid of the parasite. When the parasite is gone, the body can start to get better.

Taking painkillers is another way to get rid of the parasite. These painkillers make the pain less bad, but they also make the body weaker. The alternative could hurt the person’s health in a very bad way. Instead of trying to fix the signs of inflation, money-making loopholes should be shut down.

By closing these loopholes, money won’t be taken away from the people who make money. This will strengthen the pool of money and make it much easier to deal with the different side effects of the end of bubble activities. So, the recession will be over sooner.

Most people who make policy think that the Fed needs to raise interest rates a lot to stop the spiral of rising prices. Many people are sure that big rate hikes during the Volcker era stopped the spiral of rising prices. For example, in May 1981, Fed chairman Paul Volcker raised the fed funds rate target from 11.25 percent in May 1980 to 19.00 percent. In April 1980, the annual growth rate of the CPI was 14.8%. By December 1986, it had dropped to 1.1%.

Since there is a good chance that the economy’s wealth pool is in trouble, an aggressive rise in interest rates is likely to make the recession last longer and get worse.

By not letting the central bank control interest rates and the amount of money in the economy, wealth destruction will stop, which will help the process of making wealth. With more real money, it will be much easier to use resources that were put in the wrong place.

The Fed has raised interest rates because prices for goods and services have gone up a lot in recent months. If the Fed used the right definition of inflation, which is a rise in the amount of money in circulation, it would find that a tight stance on interest rates is very bad for the economy. To stop inflation, you have to realize that it is caused by an increase in the money supply, not by an increase in prices, and then act accordingly.