Does Raising Interest Rates Help Inflation? | Huntsville, Alabama Housing Market News
Interest rates are at the highest levels that they've been in 20 years and inflation is at the highest levels that we've seen since the 1980s. The Fed continues to raise interest rates to combat inflation but does raising interest rates actually impact and lower inflation?
Economics comes down to supply and demand. Most purchasers of big-ticket items such as boats, cars, and homes are also borrowers. Raising interest rates affects the demand for those products because the purchasers are likely to borrow less as a result.. The ‘wealth effect’ is another factor that affects demand. As interest rates rise, that typically has a negative impact on the stock market as people's stock portfolios and 401ks are worth less which also makes them less likely to borrow or purchase goods.
There are a few challenges when it comes to the strategy of raising interest rates to decrease inflation:
1) Housing is Factored Into Inflation
In fact, it's the largest expense for most Americans whether it be your mortgage or your rent so raising interest rates only increases this expense. For example, a $300,000 loan on a 30-year fixed mortgage of 3% was $1,265 a month. Compare that to rates in the 7% range, that loan is now a $1,996 a month payment which is a 58% increase. Not only do mortgages rise during periods of high-interest rates, but it also helps justify raising rents because rents need to be somewhat in line with mortgages to help make that balanced.
2) Supply & Demand Imbalance
The other challenge to decreasing inflation through raising interest rates is how it artificially manipulates demand, thus affecting supply. As you raise interest rates, that artificially manipulates the demand for housing in the economy. As interest rates rise, demand shrinks. But as interest rates shrink back down, you're going to have that demand get elevated once again. Since we already have a supply imbalance in the economy, we're not fixing that. We're actually making it worse.
We have a 5.5 million home deficit, but we're making it worse by raising interest rates. We're scaring off builders from building new construction and they're actually slowing down with these heightened interest rates. The next time interest rates do come back down in the next year or two, we're going to possibly have a more extreme imbalance in supply and demand than we do now.
We're going to have that demand once again with lower interest rates but the supply may be even more imbalanced with fewer homes currently being built. By raising interest rates, the Fed is artificially manipulating the demand in this country but not affecting the main source of challenge which is the 5.5 million home deficit.
If you can buy a home in this market, take advantage of these more favorable buyer conditions because we're not likely to experience that as interest rates start to decrease again. By taking advantage of the more favorable buyer conditions now, you can then look to refinance as rates go back down.Posted by Matt Curtis on