“Everything evolves through a process, which can be plotted in a simplistic manner as represented by a bell curve. During the early phase of the bell curve, rising interest rates do act as a deterrent to inflation. But it is not the simple balance between interest rates and spending which is dictating the trend. The third component in this contango is confidence. Rising interest rates will induce greater savings and less spending, provided the consumer has confidence in government and banks along with a firm belief that prices are not going to rise more than the rate of interest return. However, if that confidence in government and/or banks declines, consumer spending rises even faster than before, as is the case in Argentina during the 80s and 90s and Germany during the early ’20s.

In the case of a gold standard era such as the Great Depression, the rate of spending declines but the hoarding of gold increases. Hyperinflation, such as in Argentina in the 1980?s and Germany in the early 1920?s, emerges when the consumer cannot hoard gold and thus he hoards tangible goods which causes prices to escalate rapidly. When gold is available, as was the case in the AS during the 1930?s, money supply contracts causing deflation as consumers hoard their gold by withdrawing their saving from the banks. In each case, the consumer’s lack of confidence in the system remains the common denominator and the effects of deflation and hyperinflation become indistinguishable in the final analysis. If interest rates and their effect upon the system were truly linear, then neither trend would be possible. Government could theoretically raise interest rates fast enough to prevent hyperinflation or lower them fast enough to prevent depression. Unfortunately, the Federal Reserve lowered its discount rate from 6% to 1.5% between 1929 and 1931, faster than at any time in history, with no effect whatsoever in relaxing the deepening depression. Interest rates rose rapidly during the hyperinflation of Germany and Argentina, again with no effective change in trend.”

hattery says:

July 31, 2012 at 5:36 pm

“When we look at inflation in raw materials starting in 1986, government’s attempts to curb inflation through raising interest rates at this time reduces the incentive to expand production. Hence, shortages prevail and prices rise. Raising interest rates to curb inflation only works on the left side of the curve when hoarding and speculation prevail. But at some point in time, higher interest rates cause higher costs and lower production which fuels inflation.

Reply