Why Cutting Interest Rates Causes Inflation Explained

In today's video, I'm going to explain to you why cutting interest rates is inflationary. So here's what inspired me to make this educational video. I made a video covering the CPI inflation report a few days ago. So I spoke of the relationship between interest rates and inflation. And many people don't understand the concept that lower interest rates are inflationary. Which is fine. Some people are new to this and some people genuinely want to learn. So here were some of the comments on the video. Can someone explain why the Fed cutting rates is inflationary? And here's what Chris said. Cutting rates is not inflationary. That's BS. So I don't know if he was trolling or not. But I'm just going to assume that he wasn't. Static Flame asks, how does cutting interest rates cause inflation? And there were many similar comments. So you can check the video. You can locate these comments and see for yourself. So I sincerely want to help people with financial education. And this is a good question that warrants explanation. So I'm going to give you my explanation. But first, you know what? Let's just do the simple thing and ask Google. Is cutting interest rates inflationary? So good old Google says, yes, lower interest rates can cause inflation by increasing consumer spending and demand. OK, so let me explain this to you with an example. I think that's the best way to do it. So let's say that you want to buy a home for $400,000. And let's say that your mortgage interest rate will be 7%. In that case, your monthly mortgage payments will be $2,661. Now, if you lower the interest rate to 3%, then the monthly mortgage payment falls from $2,661 to $1,686. Now, I want you to think about this. If you lower the interest rate, then it lowers the cost of borrowing. And in this situation, more people will now be able to afford to buy a $400,000 home. Therefore, this will increase demand. And when there's more demand, prices go up. And for this specific situation, if mortgage interest rates go to 3%, then can you imagine the investors? They're going to start buying homes like crazy. The demand would be extraordinary, and it would drive up home prices. Now, let me give you another example. Let's say that interest rates are at 0%. So would you leave your life savings in a savings account or CD that pays you 0%? So I'm asking sincerely. I'm guessing that you would not because you would lose to inflation, right? So what would you do? You would most likely take that money and buy stocks, so that you can hopefully make more than 0%. But if everybody's buying stocks, there's more demand for stocks, and the stock market goes up. And this is a situation of financial asset inflation fueled by lower interest rates. Now, something else to point out. I guarantee you that if credit cards drop their interest rate down to 0% indefinitely, then we would see people spending more. Demand would increase and prices would go up. So just think about it. Companies offer 0% financing as a way to promote sales because it increases demand. So I'm sure that you've seen those promotions before. Now, you must understand this. This is so important because if you don't have the full picture, then you're going to have it all wrong. To clarify, cutting interest rates will not always lead to higher prices. So let me explain. Lowering interest rates adds inflationary pressure. However, it may not always drive prices up. So let me give you two examples. So example number one. If the Federal Reserve cuts interest rates by, let's just say, 0.25%, that's a small rate cuts. And consequently, it will have a small impact on inflation. Therefore, prices will probably not surge from such a small rate cuts. So I hope that makes sense. And here's example number two. Lower interest rates may be overshadowed by the impact of a greater force. So for example, let's just say that the Federal Reserve cuts interest rates from 4.5% to 1%. So that would be a big rate cuts, right? But if the economy falls into an economic depression, then prices would fall tremendously. So in this situation, lower interest rates add inflationary pressure. However, the economic depression adds deflationary pressure. So you have these two forces battling each other. And in this example, an interest rate cuts may not cause prices to go up because the inflationary pressure would be negated by an economic depression. Okay, so we just covered how lower interest rates stimulate demand, which makes prices go higher. Now, here's another very important aspect of this. If you cut interest rates, that will weaken the US dollar. Higher interest rates increase the value of a country's currency. Lower interest rates decrease the value of a country's currency. So if we cut interest rates and the dollar weakens, then it will drive up the price of imports. Because if the dollar is weaker, then it will take more dollars to buy foreign goods. So I just want you to think about it like this. Let's say that you go on a vacation to Europe. And let's say that the dollar is strong. So let's say that you can exchange 100 US dollars for 120 euros. And let's say that you get a nice dinner with someone for 100 euros. Then that's going to cost you $83.33. But now let's just say that the US dollar weakens and that $100, it now only gets you 80 euros. So if you get that nice dinner with someone for 100 euros, that's now going to cost you $125. So you see how big of a difference it makes when your currency is weaker. The same thing just got much more expensive for you. Now, I want you to think about that on a grander scale. If we lower interest rates, then the US dollar weakens. And then the price of our imports inflates. But to clarify, it's the same thing here. Lowering interest rates weakens the dollar. However, it does not guarantee that the dollar will weaken in comparison to other currencies. So I'll give you another clear-cut example. So if we cut interest rates, it's going to weaken the dollar, right? But if the Europeans cut their interest rates, that will weaken the euro. So here the effects may offset. So this is a case of lower interest rates, a weaker dollar, but prices don't go up. And here's another scenario. If we cut interest rates, but Europe cuts interest rates even more than we do, then we could actually see the value of the dollar strengthen. And this would be another case of lowering interest rates and prices don't go up. However, a lower interest rate still hurts the dollar. But in this example, the Europeans hurt their currency more than we did to ours. So it's all relative. But in the end, lowering interest rates adds inflationary pressure. That's why people say that cutting interest rates is inflationary, which it is. So I hope this helps people understand the relationship between interest rates and inflation. Okay, so that is your high-level overview. And if you have any questions or comments, please let me know down below. As you can clearly tell, I do read the comments. I look forward to reading them. Please subscribe. Thank you for the support and wish you a very nice day. Take care.