For my weekly assignment, I was asked to talk about a government regulation that affects interest rates. Inflation is not really a “regulation†but it is something that the government does that affects interest rates; hence I have elected to write about it here.
Inflation is essentially the addition of new money into an already-existing currency, like the printing of new money, or when gold is turned into new coins. Inflation occurs over long periods of time, but (at least right now) is steadily happening, and shows no sign of stopping. Inflation is the devaluation of the dollar. New money, when printed, wasn’t worked for. It is just added into circulation. Here is an example which is much easier to understand: If there are one hundred coins of the exact same value on the entire planet, then each of those coins is going to be worth more than if there were one-thousand of those same coins. When new money is printed, money becomes less rare, and therefore, less valuable. What is the result of this? It costs more money to purchase the same amount of goods. If we were to time travel back in time to 1950 with a modern dollar, we would be able to buy about $12.50 worth of goods because of inflation.
Now that we understand what inflation is, I can tell you about how it affects interest rates. Inflation means that your money looses value over time. If someone put $12.50 in a time capsule in 1950 and someone in 2023 dug it up, that money would have lost a lot of purchasing power, and so essentially that person lost money. It works the same way with loans. If a bank lends someone $30,000 today, and the term is 30 years, that $30,000 will have less purchasing power than if they used it today. This means that banks lose money. The way that they fix this problem is by increasing the interest rate so that it keeps up with inflation. They will end up with more money than they started with at the end of the loan’s term, and, if the rate was high enough, they actually gained money instead of losing it.
That pretty much sums up how inflation affects interest rates. It means that in order to keep banks from losing money, they have to charge more interest on the loan. That is one way that the government affects interest rates.