Rising interest rates and prices

Given the recent spike in interest rates amid concerns about inflation, the markets are responding with some turmoil. Prices are changing, but it’s not as dramatic as it seems because there tend to be offsetting effects, which bring things back in line. Here are some cases of why you shouldn’t be worried.

When inflation goes up, so do other interest rates, which means real prices do not change. For example something that costs $10 goes up in price to $10.50. This seems like a big increase, but you probably got a pay raise too, and your bank interest rates are also higher so instead of earning $.10 in interest, you may earn $.25 or even $.50 for the same $10 in your savings account. The real rate of inflation doesn’t change as much.

Mortgage interest rates go up, which makes mortgage payments higher, so less people can afford them. This reduces demand slightly, resulting in lower house prices. The lower house price at a higher interest rate can come out to about the same monthly payments.

Though there are pretty fast currency exchange shifts, internally within a country everyone gets hit by the same rate change and prices tend to be sticky, meaning they don’t immediately respond up and down as quickly. For example with the price of labor, rarely would employers ask people to take pay cuts, which means they are less willing to give raises because they know they can’t undo the wage increase. Similarly, prices for items in a store don’t go up every year by inflation. Companies keep prices steady until they absolutely have to increase them.

All this isn’t to say that there aren’t real world implications when interest rates change. The changes disrupt lots of plans because now you have to recalculate your finances and possibly make different decisions. Changes also impact the currency relative to others so if you travel, it can either be a benefit or hurt your budget. But if you’re staying at home, there’s nothing to worry about in the long run.

 

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