[georgeecollins]

Here's my try: - Unlike popular perception, money is not created by "printing it". Money is created, or the supply of money is added to, when entities (corporations, institutions, people) borrow money from a bank.

- When interest rates go up, the cost of borrowing goes up because you have to pay back more over time.

- When the cost of borrowing goes up people borrow less.

- When their is less borrowing their is less money in the economy. Less of a currency trying to purchase the same amount of goods lowers prices.

[mywittyname]

Lots of companies make money from the cash flow spread between interest rates and whatever their investment is. And when interest rates rise, entire segments of their business become fundamentally unprofitable. It's not just banks either.

Say a company buys a $100k asset, and they can use it to generate $10k in revenue. That's a profitable investment at 5% interest ($5k), but not at 10% ($10k). So at high enough interest rates, it's not economically viable for that company to expand. That lack of expansion has upstream implications, and can have a cooling effect on asset prices at broad levels.

[apropos_g]

> and can have a cooling effect on asset prices at broad levels.

Well asset prices aren't the prices of food and gas.

[apropos_g]

> ... borrowing... borrowed...

Borrowed money is rarely spent on food and gas.

You can be stupid and talk about buying food and gas on credit cards. Very few people in this country will stop buying food and gas to prevent default. People need food and gas to survive. So it's not really the borrowed money that is spent on food and gas.

[yongjik]

Oh, but people will stop buying so much food and gas, just not directly. Without enough money, some people will cancel their planned trip to Hawaii. That's a lot of gas not burning right there. Or they won't buy another TV, which needs gas to be delivered to your home. With less people competing for precious gas, its prices drop.

[apropos_g]

> Without enough money, some people will cancel their planned trip to Hawaii.

By this logic, why doesn't Congress illegalize travel? Is that going to reduce the cost of travel? Will that reduce CPI, which measures prices, not demand?

> Or they won't buy another TV,

What if we illegalized buying TVs? Would that make TV prices fall? You think that is going to reduce CPI?

I'm not saying your explanation here is stupid. It is the first one in a while that seems to at least appeal to common sense. I am just trying to show that CPI measures prices, it does not measure demand or supply alone for goods.

> With less people competing for precious gas, its prices drop.

Gas prices rise and fall all the time. Lots of factors go into its price. You could illegalize gas, would this cause the price of gas to rise or fall?

[yongjik]

> > Without enough money, some people will cancel their planned trip to Hawaii.

> By this logic, why doesn't Congress illegalize travel? Is that going to reduce the cost of travel? Will that reduce CPI, which measures prices, not demand?

Hey, you asked for a "common sense explanation" how the policy works, and people gave it to you. If your intention was "I want to debate unrealistic what-ifs with as many people as possible," then you could have made yourself clear in the first question.

[tick_tock_tick]

> By this logic, why doesn't Congress illegalize travel?

Because then the money just gets spent in other places shifting around the inflation.

[stu2b50]

You’re talking on a micro level, the OP is talking about macro monetary theory. It’s not about individuals borrowing money, it’s about companies and banks borrowing money and how difficult that is. Monetary supply past m1 is produced by banks borrowing and lending money, and limiting that directly limits monetary supply.

[HPsquared]

Money circulates between people. Person A takes out a loan and pays person B to do some work. Person B buys food and gas with the money.

[apropos_g]

Person A stops paying person B.

Is person B going to stop buying food and gas?

[HPsquared]

I suppose he could barter for it.

If person A holds on to the borrowed cash and doesn't spend it, that money doesn't circulate (the velocity of money decreases).

If person A doesn't take the loan, there is less money in the system (money supply is reduced).

If there's less money circulating, people won't "bid-up" the prices of food and gas as much, reducing their price (assuming constant supply of food and gas).

[rtkwe]

Person B might not be able to afford the gas in food now so possibly. The main way it functions is ultimately depressing wages and putting people out of work so there's less demand.