COST OF MONEY
Are prices high because there is too much money in the economy? Too many people are too rich and spending too quickly? Something must be done.
In a real-world example, if you were the manager of a local car dealership and you couldn’t keep the cars on the lot because you were selling them faster than you could resupply them, times are obviously good. But how can you make money and pay your employees if there are no cars to sell?
What would you do to manage the situation? You would likely raise prices on the cars and slow demand a bit. You would attempt to align supply with demand. If demand is too high, you’ll have an empty car lot. That won’t make your salespeople happy. If you raise prices too much, you’ll slow demand too much as few people could afford your vehicles and your supply of cars will rise.
You want a balanced strategy. You want to make a small change and see if it makes an improvement. Better, but not quite? Make another small change and see how that helps. Remember, you are seeking balance and steady growth, not a shock to the system.
So what would you do if you were in charge of the U.S. economy and it was also red hot like the car dealership? Raise prices, too? Likely!
You would actually increase the price of money by raising interest rates. This makes money more expensive because it will cost more to borrow from a bank, to get a mortgage, and to charge on a credit card. Consumers would likely slow down their spending. It will also spur businesses ...