Dear friends, can you enlighten me? RE: increase in Prime Rate.

[Paper Roses]

I cannot understand why the raise in Prime Rate by the FEDS is going to help this economy. By raising the rate, the prices are going to go up everywhere. This will make life more difficult for all of us.

Everything we do will be subject to raised prices. This move will hurt all of us, no matter what our situation.

I don't understand the reasoning, Why is this happening? I heard it will be 6 times in the coming year. I'm sick to death about this. As a senior on limited income, things are tough enough now.
There are other factors that effect my thoughts but I'd love to know how this particular move is supposed to help those of us who have to struggle to put food on the table...and everything else.
Since you are experts, is there a simple way to explain this?

[elleng]

1. I'm with you!

Almost everything the Fed does is counterintuitive to me (but what do I know, just a retired attorney.)

[spooky3]

2. The logic is this: if rates increase, people can't as easily borrow money

To spend on cars, houses, vacations (though mortgages are influenced by some other factors, too), etc. Businesses also have to reel in spending. So, there is less demand. If supply stays constant, or increases, prices will go down because suppliers want to attract customers, to sell their stuff.

For example, I saw a real estate newsletter that said someone who had to borrow and could afford a million dollar house earlier this year now can afford only $800000. So, that should slow the increase in housing prices and maybe cause a drop.

[A HERETIC I AM]

3. Spooky has it right, and if I may expand a bit....

Cheap money means more borrowing and more spending. That's fine if there are plenty of goods and services available, but right now that's not the case.

Have you noticed how empty car dealership lots are? Your average GM, Ford or Chrysler dealer normally would have dozens of new cars and trucks on their lots, several of each model in different colors and trim levels, etc. Some dealers lots are pretty much empty.

These days, the only full lots are at used car stores, like CarMax, etc. because the used car market does not depend on computer chips from Taiwan (and other items in short supply) to install in new vehicles, though inventory is tightening because people aren't trading in their cars because they can't get new ones!

So in that one sleeve of the economy alone, you can clearly see inflation in action. People have money to spend, but there are not enough goods to go around.

So things become more expensive. The laws of supply and demand in action.

By raising the Prime Rate, the Federal Reserve Board hopes to trim back demand so prices will fall. That's all there is to it.

[progree]

4. Fed Chair Paul Volcker raised interest rates way high in '79-82 and is credited with

bringing inflation way down. The problem at the time is that it also brought on a double-dip recession (which has the effect of reducing inflation or even causing deflation).

It's just about impossible to bring down inflation without severely slowing the economy, and that's the problem now.