this post was submitted on 03 Sep 2023
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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. That is why interest rates rise alongside inflation. Interest is the cost of money, so when demand for money increases, the cost of money rises to maintain equilibrium. Same reason why, all else equal, the cost of bread increases when demand for bread increases. Basic supply and demand.
If you can get inflation under control then debt becomes far less interesting, certainly. 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. The higher the rates, the higher the inflation.
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.
Yes, this was covered in the earlier comment. Was there some reason to not read it?
I have no idea where you think a free market enters the picture โ there is no free market found in Canadaย โ but yes, the central bank responds to the market behaviour. We already went over this. Why not just read the earlier comment?
Yes, high enough rates would. The BoC has been afraid to go there, though. Right now they're focused on maintaining equilibrium. They still hope inflation is a transitory COVID-19-related issue.
Which is not unwarranted. There is still a lot of evidence of that being the case. The farm gate price of food, for example, is down ~50% over last year. That takes some time to work its way through the supply chain into the grocery store, but it is highly likely that food is going to face a reckoning in the coming months. The inflationary impact of higher rates will be no match for deflation in food.
But what if that deflation in the rest of the consumer economy doesn't happen? For example, a lot of people think the USDA is misreporting the food situation that has caused prices to drop so significantly. That has happened many times before. It doesn't take much to see that 50% drop return with a 100% climb once final harvest numbers are in.
Yes, we have responded with 20% interest rates before. But can that happen this time without sending us into depression? Housing, and the mortgages associated with them, has become central to the Canadian economy. The BoC was created during the Great Depression to prevent future depressions. The inflation target mandate is important, but it does not supersede the mandate to keep Canada's economy reasonably healthy.
Hey, I'll be happy to maintain a civil conversation but I won't entertain rudeness. Have a great day!
Are you referring to where one @frostbiker kept repeating the same thing over and over and over again, wasting everyone's time for no reason? That was pretty rude, I agree, but there was still enough interesting things to discuss that I don't know that we have to throw the baby out with the bathwater.