How does raising interest rates control inflation? — Transcript

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1. 0:00when central banks raise interest rates
2. 0:03it's big news bank is judging that the
3. 0:06only way they can try to pull down
4. 0:08inflation is to carry on raising
5. 0:10interest rates we're going to see rising
6. 0:12rates rising interest rates that will
7. 0:14make the cost to borrowing go up it can
8. 0:17send ripples across the whole economy
9. 0:20it can sink consumer confidence result
10. 0:22in fewer jobs and lower wages and cause
11. 0:26stock prices to fall if they go too far
12. 0:29too fast it can tip economies into
13. 0:31recession
14. 0:32so
15. 0:33why do central banks raise interest
16. 0:36rates
17. 0:37[Music]
18. 0:46let's start with the basics
19. 0:48if you borrow money you'll have to pay
20. 0:50back a little extra to make it
21. 0:51worthwhile for the lender well i think
22. 0:53we can make you this long you have a
23. 0:55good reputation we know you're reliable
24. 0:57i'm glad you think so
25. 0:59this is the interest rate
26. 1:02so if you are taking out a loan you want
27. 1:04the interest rate to be as low as
28. 1:06possible so you don't have to pay that
29. 1:08much back
30. 1:09on the flip side if you want to save
31. 1:11money then a high interest rate means
32. 1:13you can earn more on your savings
33. 1:16see it as a reward for leaving money in
34. 1:18your account but the size of your reward
35. 1:20depends on the circumstances
36. 1:23there's no single interest rate in the
37. 1:25economy you've got thousands of banks
38. 1:27setting their own commercial rates
39. 1:29that's all influenced though by the
40. 1:32interest rate that the central bank sets
41. 1:37a central bank is like a bank for banks
42. 1:40just like you and your savings account
43. 1:42banks also earn interest when they leave
44. 1:45money with a central bank
45. 1:47commercial banks have these things
46. 1:49called reserves so that's a bit like
47. 1:51their cash on hand
48. 1:53commercial banks lend those excess
49. 1:55reserves to each other at an interest
50. 1:57rate and they also can deposit their
51. 1:59excess reserves at the central bank
52. 2:02and when they do that they can earn an
53. 2:04interest rate
54. 2:05ordinary people can't access the
55. 2:07interest rate on the excess reserves but
56. 2:10it still affects them
57. 2:12and that's the idea
58. 2:14when central banks raise interest rates
59. 2:17they're trying to control inflation how
60. 2:19fast prices rise for everyone they were
61. 2:22129 now they won 39 and last in the
62. 2:25space of four weeks central banks like
63. 2:27the fed or the bank of england or the
64. 2:30european central bank are all trying to
65. 2:32hit an inflation target of two percent
66. 2:35interest rates are a really powerful
67. 2:37tool that they have to do that
68. 2:40if inflation is seen as too high
69. 2:43that's when banks raise interest rates
70. 2:46the change spreads through the financial
71. 2:48system and slows down the rate of
72. 2:50inflation
73. 2:52here's how
74. 2:53a rise in interest rates from a central
75. 2:55bank means that a commercial bank will
76. 2:57earn more on their reserves
77. 3:00they might make more from keeping their
78. 3:01money in a central bank then lending it
79. 3:04out
80. 3:05so if they do lend it out they'll raise
81. 3:08their interest rates to make it worth
82. 3:09their while
83. 3:12how that affects consumers depends on
84. 3:14the economy
85. 3:15take mortgages
86. 3:17in places like finland or australia
87. 3:20lots of people have mortgages with
88. 3:22variable interest rates
89. 3:24if you've got a variable rate mortgage
90. 3:27where the interest rate that you pay is
91. 3:29linked to the central bank's interest
92. 3:31rate then higher interest rates mean
93. 3:33that essentially immediately the higher
94. 3:36rate will translate into less cash to
95. 3:38spend on other things
96. 3:40less spare cash means households will
97. 3:42spend less
98. 3:44and less spending means businesses will
99. 3:46be warier of raising prices this should
100. 3:50lower inflation
101. 3:51in other countries like america or
102. 3:53canada a bigger share of mortgages are
103. 3:56set at fixed rates
104. 3:58people with fixed rates are protected
105. 4:00against the direct effects of an
106. 4:02interest rate rise
107. 4:04but will still feel an indirect impact
108. 4:07higher interest rates mean that
109. 4:09mortgages will become more expensive
110. 4:13if that is affecting all new buyers then
111. 4:17house prices will begin to fall and that
112. 4:19will make everyone who owns a home feel
113. 4:22poorer and therefore they might spend
114. 4:24less
115. 4:25lower spending will translate into lower
116. 4:28inflation
117. 4:29and it's not just consumers who will
118. 4:32tighten the purse strings
119. 4:33when interest rates rise then businesses
120. 4:36will find it more expensive to borrow
121. 4:38and invest
122. 4:40that generally means less economic
123. 4:42activity it might mean fewer jobs are
124. 4:46created
125. 4:48fewer jobs and lower wages could mean
126. 4:51less money for households and consumer
127. 4:54confidence might suffer which also means
128. 4:57less spending
129. 4:58people are grappling with a decline in
130. 5:00real wages meaning their money buys less
131. 5:03when interest rates rise that will tend
132. 5:05to slow down spending investment and
133. 5:08generally depress economic activity
134. 5:11overall that will make businesses more
135. 5:14reluctant to raise their prices
136. 5:17and that will tend to pull back
137. 5:18inflation
138. 5:19it sounds straightforward right
139. 5:22but the trick is judging how far to go
140. 5:25in 1981 the federal reserve america's
141. 5:29central bank allowed interest rates to
142. 5:31rise to a whopping 19
143. 5:34the move curbed inflation but it led to
144. 5:37widespread economic pain
145. 5:40i regret to say
146. 5:41that we're in the worst economic mess
147. 5:44since the great depression
148. 5:45it is very difficult to get inflation
149. 5:49under control
150. 5:50without severely denting economic
151. 5:52activity in america it's been over 70
152. 5:56years since they've managed to get
153. 5:59inflation down from over five percent
154. 6:01without causing a recession
155. 6:04a little inflation is okay it keeps the
156. 6:07economy moving at a sensible speed but
157. 6:10inflation staying high for too long is a
158. 6:13problem
159. 6:14higher prices means employees will need
160. 6:16higher wages pushing up costs for
161. 6:19businesses that could drive up prices
162. 6:21further potentially leading to an upward
163. 6:24spiral of wages and prices
164. 6:26retail inflation india has surged to 7.8
165. 6:29percent the combination of step 8
166. 6:31economic activity and high inflation
167. 6:33poses serious challenges for indian
168. 6:35economy going forward central bankers
169. 6:37are really concerned about setting
170. 6:39expectations of inflation the idea is
171. 6:42that if it can show that it is credible
172. 6:44that it will always act to get inflation
173. 6:47back down to two percent then maybe it
174. 6:50won't have to you know raise interest
175. 6:52rates and then lower them in this kind
176. 6:54of seesaw fashion
177. 6:56raising interest rates can slow an
178. 6:58economy right down the trouble is the
179. 7:01brake pedal has a delay
180. 7:04it can take as long as two years to see
181. 7:06the full results from interest rate
182. 7:08changes
183. 7:09central banks know this
184. 7:11so when they set interest rates they're
185. 7:13actually trying to read the road ahead
186. 7:16but predicting the future isn't easy
187. 7:20the problem is it's difficult for the
188. 7:22central bank to work out whether the
189. 7:24inflation will fall back on its own and
190. 7:27even when central banks do get it right
191. 7:30they might still cause a crash
192. 7:32it may be a blunt instrument
193. 7:35but raising interest rates is still
194. 7:38central bank's main tool for taming
195. 7:40inflation
196. 7:41central bankers would say that yes
197. 7:43raising interest rates can be painful
198. 7:45slowing down the economy is not fun
199. 7:48but it's worth it it's worth it to get
200. 7:51low and steady inflation so that in the
201. 7:53long run you don't have to think about
202. 7:55it
203. 7:58thank you for watching to read more of
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