Interest Rates and Inflation

Inflation involves the rising of the price for goods whereby the consumer looses purchasing power. In order to compensate for this lenders raise their interest rates in an attempt to recover the money lost by the value of the currency dropping.

As prices rise consumers require more money to be borrowed to purchase homes, cars or to make improvements to their existing home. Since there is an increased demand for borrowing money interest rates rise again. It’s a never ending vicious cycle.

As a citizen you have little ability to battle inflation since it’s caused chiefly by governments. Inflation can be caused in several ways; printing of additional currency, high government borrowing, or deficit spending.

You may not have much you can do as a citizen but there are a few things you can and should do as a borrower. When borrowing you have a make an educated guess like the banks do on whether there will be a rise in the price of goods or a drop. This is touch even for seasoned professionals so how can you be expected to do this?

There is no guaranteed method for making these predictions; however, there are a few economic indicators that can be useful for tracking trends. Oil is so tied to manufacturing and industry that an increase in oil prices will almost certainly cause inflation to rise. So if you want a baseline inflation indicator keep an eye on oil prices in the business section of your newspaper.

Increasing prices for bonds also can be an indicator of impending inflation. Bond option prices going up indicate that financial professionals are betting that interest rates will change dramatically over the next 1-2 years.

Keep in mind when borrowing money that the money you borrow today can cost you a much different amount tomorrow. The total cost of these loans in the future can be much different than you initially anticipated.

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