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We will have low interest rates and high inflation

We will have low interest rates and high inflation

created Forex ClubAugust 25 2020

Why can we expect low interest rates in the near future? First, because economists widely believe that they stimulate the economy. And that will always come in handy in a crisis. But there is also a second reason, perhaps more important. Those who decide on the level of interest rates, that is, governments, are indebted to enormous amounts. Low interest rates enable them to service this debt.

The second reason is economic obviousness. However, the first one will remain the subject of academic and journalistic discussion for a long time. Low interest rates increase the money supply, which makes it more accessible to businesses and consumers. There is no doubt that facilitating access to financing in the short term stimulates economic activity and makes households more active in consumer markets. However, according to classical economic theory and common sense, increasing the supply of money should lead to a decline in its value. In other words, we should expect inflation and this has a negative impact on the situation of entrepreneurs and consumers in many ways.

bartosz tomczyk provema

Bartosz Tomczyk, Provema

However, it is clear that so far the increased money supply does not affect the consumer markets of the most developed countries. Consumption is so high there that households will no longer increase it just because they have easier access to money. That is why in the United States, in the euro area or in Japan, despite the crazy money printing, we do not observe increased inflation all the time. The printed money goes to capital markets, causing a boom on the world's most important stock exchanges. The situation is slightly different in Poland, where inflation was growing dynamically even before the coronavirus epidemic and the stock indices are very far from records. In Poland, at least for a while, we will most likely face high inflation and low interest rates.

This kind of situation, to put it mildly, is not very natural for the economy. It is therefore important to consider what its long-term effects will be. It is known for sure that they will not be the same for everyone.

Investors will find themselves in a relatively difficult situation. It will be difficult to achieve their favorite passive income. Moreover, they will be exposed to significant losses, because on the one hand the interest on the invested funds will be very low, on the other hand, their purchasing value will decline.   

Borrowers or indebted people will be in a completely different situation. Interest on loans will remain low, while inflation will increase not only prices but also their income. This means that paying liabilities will be easier. The government, wanting to facilitate its own debt service, will inadvertently help borrowers, including those devastated by the increase in the Swiss franc exchange rate.

However, in the long run, such a situation is very dangerous for the economy. Banks can count money better or worse and will not lend it to anyone, knowing that it will be worth less when the borrower returns it. This means that banks will tighten the criteria for granting loans, which they are already doing due to the epidemic, and consumers and entrepreneurs, instead of having easier access to financing, will not get a loan at all, because granting it will involve too much risk.

Author: Bartosz Tomczyk - chairman of the supervisory board of Polish fintech Provem

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Forex Club
Forex Club is one of the largest and oldest Polish investment portals - forex and trading tools. It is an original project launched in 2008 and a recognizable brand focused on the currency market.