Are interest rates designed to extract as much money as possible?
This is the 2nd installment in my Monetary Economics series. The first installment was:
The interest rate referred to in this article is the rate set by central banks which affects the lending rates of normal banks. How or why it affects them is not totally clear to me, nor is it important. They are almost always aligned.
Wikipedia says that “central banks of countries tend to reduce interest rates when they wish to increase investment and consumption in the country's economy”.
Another way of looking at it, could be that when people can no longer afford anything because their mortgage repayments are so expensive, central banks reduce rates to prevent a credit crunch.
Wikipedia also says “however, a low interest rate can be risky and may lead to the creation of an economic bubble, in which large amounts of investments are poured into the real-estate market and stock market. In developed economies, interest-rate adjustments are thus made to keep inflation within a healthy target range.”
This means that if the rate is too low, people will just borrow excessively and try to get rich quickly. This may be true, but an easy way to fix that would be to just ban credit creation, which drastically reduces the amount of borrowing possible (since banks can’t just create money to loan out).
Richard Werner has a 2018 paper that examines the connection between interest rates and economic prosperity.
The rate of interest – the price of money – is said to be a key policy tool… To investigate, we test the received belief that lower interest rates result in higher growth and higher rates result in lower growth. Examining the relationship between 3-month and 10-year benchmark rates and nominal GDP growth… we find that interest rates follow GDP growth.
Its a bit hard to see, but generally the blue line (interest rate) starts rising or falling shortly after the black line (nominal GDP) does. Which means that interest rates seem to follow the health of the economy.
This makes sense to me, that central banks are really just tools to extract as much money as possible from people without causing a total collapse. When people can afford more, banks charge more. When they can’t afford much, they charge less.
Its not that difficult to predict changes in the central bank interest rate. Just think, can they extract more resources from people without collapsing the economy? If yes, then the next direction will be up. If not, then the rate will stay the same. If too many people are close to defaulting, then it will drop.
Australia’s interest rate has been rising rapidly since 2020, and is set to slow down as people start complaining about their mortgages. Will they pause the interest rate, or will they increase it one or two more times before they have to let up?
Can they increase it without too many people defaulting? Probably. It sounds like they want to increase it. Experts aren’t sure. I suspect they will, perhaps just one more time. We will see next week!
Again, if they really wanted a prosperous economy, they would ban credit creation (or restrict it to business loans), and keep the interest rate as low as possible. Then people could afford houses and families, and have the motivation to work for their society, not just for themselves.
References
Ciccarelli, R. (2023). RBA boss defends 'unpopular' rate hikes during Senate estimates hearing. Nine News Australia. https://www.9news.com.au/national/phillip-lowe-rba-boss-refuses-to-declare-inflation-victory-during-senate-estimates-hearing/7ac863c2-6f8b-46c6-b5d4-19da3557b762
Lee, Kang-Soek & Werner, Richard. (2017). Reconsidering monetary policy: an empirical examination of the relationship between interest rates and nominal GDP growth in the US, UK, Germany and Japan. Ecological Economics. 146. 10.1016/j.ecolecon.2017.08.013.