The Fed recently increased interest rates to combat rising inflation. But how exactly does that work? In this video, Brendan discusses how low supply and high demand helped usher in inflation, so now the Fed is increasing interest rates to bring down demand to be more in line with the available supply of goods and services.
Economics 101 - Supply and Demand
Pandemic stimulus programs increased demand
The Pandemic reduced the supply of available goods and services
Increased interest rates seek to decrease demand
Hi and welcome to another edition of coffee with Brendon. Today we're going to talk about the Fed inflation and economics 101. So this week, it's March 22. Today, as I'm shooting this video, and less than a week ago, the Fed increased interest rates by point two 5% to combat the extremely high inflation that we've seen over the last six to 12 months. And so a lot of people say, Okay, that's great. The Fed just increased interest rates. But why why? Why does that impact inflation. And so that's what this is, this, this video is going to be all about.
So in order to understand this, you have to go back to your economics 101 course. And hopefully, it took at some point along the way, in the concept of supply and demand. And right now, where we stand, we came out of COVID. With lots of stimulus money in our pockets, people were saving some of the savings rates were off the charts. And they had a bunch of money to spend. And so they came out of COVID, and they want to spend it. And unfortunately, this supply of goods as a result of supply chain issues and things that though, we all again, kind of know about the supply of goods is very low. So when you have again, going back to economics 101, high demand low supply, that means prices go up. And if we had the the opposite effect, if we had low demand and high supply, then prices go down.
And right now, we're in this huge disconnect between the demand for goods, everyone wants a car, well, that's all refrigerator wants, whatever it is, and the seller of these goods, can charge just about anything for the for these different items. My wife, and I were just looking for a new car for her. And instead of you know, they have the internet price. And typically it says MSRP minus internet price, this is the price you pay, this company was so bold as to say, this is the MSRP, this is the premium that you're going to pay to get my car. And ultimately we'd end up having to pay anywhere between five and $10,000 more than what the MSRP is. So these are just wild times that we live in, where companies really don't care what price they put down in there, they're gonna charge it and we're gonna have to pay it because the supply of goods is so low right now.
So let's go back to what the Fed what the Fed is trying to do. So ultimately, when it comes to the economy, and again, this is a little bit of an explanation as to why the government did what it did with the stimulus checks and government spending and things like that they wanted to stimulate the, the markets, and or excuse me stimulate the economy, because we ran into a situation whereas you see right here, you know, we're on a nice little trajectory up when it came to the economy as we were going up, up, up, up, up, up, and then all of a sudden, this big thing happened here. Now, that obviously was pretty much February, March of 2020. When everything shut down, and for all intents and purposes, our economy shut down. And that could have led to a snowball effect, where the economy just stalled out. And just like when you're when you're playing and you stall mid mid flight, that's really not a good thing. And so the government took pretty over-the-top measures to keep the economy going.
And so what did they do, they attacked the two biggest pieces of what drives an economy, one consumption, they just threw money at the consumer. And that makes up more than two-thirds of what happens in an economy. And then there were just ginormous amounts of and that's a official term, ginormous, amazing amount of government spending. And so that is pretty much what they did to jumpstart the economy.
And so fast forward to now or backup here. So the economy has been restarted. But now we're just flushed with all this money that people want to spend. And so what the Fed is trying to do is trying to tamp this down and try to reduce demand. So it's a little bit more in line with the supply of goods that are out there right now. And so what is the number one way to shut down this consumption number is to increase interest rates because what does an increased interest rate ultimately do? So when you so when the Fed increases As interest rates, what ultimately they're doing is they're telling all the banks that they're connected to that the going rate for whatever is point two 5%. More.
So on the positive side, that means that your the interest rate that you're getting on your CDs, your checking or savings should go up. If your bank doesn't increase rates, then you might want to be looking at a different bank. On the flip side, they also are now charging more for mortgages, auto loans, and one of the biggest drivers of consumption credit cards. And so that's what the Fed is trying to do. They're trying to reduce the demand that we have as consumers who drive two-thirds of the economy to slow down our buying so that it's more in line with the supply of goods.
And really, I could keep going on on this all day. But you know, these videos, I'm trying to keep the five to 10 minutes, so I'll just leave it at that, you know, ultimately, when the Fed increases interest rates, it's a good thing for your checking and savings accounts, because hopefully, it'll be getting a little bit more interest. And then and that naturally drives people from spending to saving, you know, just because now it's a little bit more attractive to save your money at the bank, as opposed to, you know, either keeping it in cash or just spending it.
And on the flip side, it makes it more painful to actually borrow money and buy a new house and buy all the curtains for the house and, and hire someone that is going to you know, fix up your house and all those other things that go along with consuming. When you increase the interest rates and what it costs to borrow money, whether it's your home equity line, whether it's credit cards, whatever, it slows demand for services, demand for goods down. So again, quick little lesson on what's going on here. And really at this point, that's that's really what you need to know about it.
If you have any questions about this, feel free to ping me I'm happy to talk about this in more detail. But this is really kind of the long and short of what's going on right now. So hope you enjoyed this episode and look forward to our next episode. Take care
The LPL Financial Registered Representatives associated with this site may only discuss and/or transact securities business with residents of the following states: CA, CO, CT, DE, FL, GA, ID, IL, IN, MA, ME, MT, NC, NH, NJ, NY, OH, PA, RI, SD, TX, VA & VT
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.