Stable prices are a macroeconomic consideration for nations and the places contained within their boundaries. For places, changes in inflation or changes in the prices of a basket of goods may be difficult to drill down to a sub-regional and city or town spatial scale.
A typical measure for inflation at the national level is the CPI (Consumer Price Index) that measures the change in price levels for consumer goods and services purchased by households. Here, a typical ‘basket’ of goods and services as a representative sample is selected and the change in price is recorded over a period of time (mainly over a year). A high percentage change in prices of goods would mean that inflation is running high, and this may in turn de-value in ‘real terms’ other economic features of an economy.
For instance, if wages remain constant (at say $30,000) they will be reducing in ‘real terms’ if goods and services are increasing in price over time. As such, less goods and services can be purchased with the same amount of income, so hence the real wage has dropped. Also for the wealth of a nation, if inflation is running high it will mean that ‘real growth’ will be affected as the growth figure as GDP could have increased simply by a rise in the price of goods and services more broadly.
The measurement of CPI is therefore critical to what level of inflation is used and applied to other economic features. What is in the ‘basket’ of goods and services will determine how the overall increases in prices are generated. For instance, if food is in the measured basket of goods and the price of food is increasing rapidly, so will the measure of inflation.
If energy goods are included in the basket of goods and the price of oil is increasing, the measure of inflation will therefore be rising. CPI (as different to RPI – Retail Price Index) often excludes some property-related goods and services to such as rental and mortgage payments and therefore can be argued to mask any property related changes in the economy.
Inflation measures will therefore not include price rises where consumers pay high housing costs through rental increase or if they pay higher loan-mortgage (variable rate) payments if there is an increase in interest rates. In places, therefore, where there are a greater proportion of property owners and economic concerns over property price and interest rates, the interconnection and transmission of interest rates and inflation are particularly pertinent.
Nationally, a government will be concerned with maintaining stable prices as per their principle macro-economic objectives. If measures are demonstrating that prices (or inflation) are starting to rise this will mean that action to curb such inflationary activity may be called upon.
One particular lever to control inflation is through interest rates and this is often set by the bank of the particular economy responsible for its economic interests. Committees such as Monetary Policy Committees often set the interest rate in accordance with the inflation target set by the Head of The Treasury (or similar institution). If the inflation target (e.g. 2% annual rise in prices) is being exceeded or not being met by a certain parameter (e.g. 1% on either side of the target) the committee’s often decide whether to act by raising or lowering interest rates in order to put the ‘brakes on’ or ‘brakes off’ the price changes.
There will be pressures from many individuals and groups that will be affected by changes in interest rates. In particular, there is considerable pressure from forces interested in property and from investors that may choose to invest in property (or seek returns elsewhere).
If interest rates were raised this would mean that the cost of borrowing money, or as previously discussed the value of money becomes more expensive. Using property in particular as an example, the result of this increase in interest rates (e.g. 2% to 5%) would mean that there would be less investment in property and a greater incentive to save and keep money in the banks.
The banking system would particularly put pressure to raise interest rates as they will be able to recoup some larger interest payments. However, from an economic growth perspective, there is pressure to keep interest rates low – as it would be in the interest of the economy to have goods and services being invested in so that jobs, income and wealth are promoted. Using the example of housing, if interest rates are low, the number of mortgages taken to purchase property will increase demand and thus boost the amount of building on aggregate.
Furthermore, if interest rates are low, property companies can borrow more to invest in building further developments to extend or modify places. A macro-economic conundrum in setting interest rates may occur though if inflation is rising but with low growth in the economy, meaning that a rise in interest rates to curb rising prices could further stifle economic growth.
Stifled economic growth means that investment for growth rather than inflation has been a significant priority, along with an additional investment problem compounded by a lack of credit finance for individuals and companies. The attempt to loosen credit in the system globally has been through a series of injections of money into the economic system via a printing of money (sometimes termed as quantitative easing).
The mechanism to make this happen is in simple terms by writing bonds (a form of an ‘I owe you’) by the national bank to its borrowers (e.g. investment and high street banks) in exchange for receiving cash. This bond (or ‘I owe you’) will have to be recouped at some future stage and thus will mean that in order to do recoup the lending pressure on raising interest rates will emerge at a future date when it is hoped that economic growth has returned.