The base rate sets inflation in the economy...

cells

An idea...

At its most basic person A and B can agree between themselves for A to give to B a house and they create 100,000 credits index linked credits and debts in a ledger and for B to pay over a 25 year period a sum of X credits a month. They have created a debt/credit interest system between themselves. Banks just make this agreement infinitely tradeable and much much more useful and fluid and lower overheads.

Person A and B dont want to break the contract and they want to fulfill their agreement and the only way for that to happen is if the real rate of interest agreed is sustainable as a transfer of wealth from B to A. Lets say the sustainable real rate of interest from B to A is 2%.

If the interest rate chosen was very high lets say 10% then in the economy inflation has to be 8% or the loan is unsustainable. So person B will demand 8% higher prices from person A and they will get it as that is the only way for the arrangement to be sustainable.

If the interest rate chosen was 20% then the rate of inflation has to be 18% or the loan is unsustainable so inflation will have to be 18%

If the interest rate chosen was -5% then the rate of inflation has to be -7% to again keep the net sustainable transfer as 2% from B to A.

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Of course it gets more complicated as you go from an economy of just 2 people to say 2 million or 20 million or 200 million people and with the banks acting as middlemen

However what fundamentally changes? If the debtors and creditors are to operate in a sustainable stable system the net transfer of wealth from debtors to creditors needs to be sustainable and the only way for that to happen is the only other variable in the equation and that is inflation.


So if Cells Theory of Inflation Mark 1 holds and for this argument lets take 0% as a sustainable real rate of return from debtors to creditors. IF the bank of England was to put rates up to 5% in the mid term inflation in the economy would have to be ~5%. If the BOE put rates to 10% inflation in the economy would have to go to 10%. If the BOE put rates to 0% inflation would have to go to 0%....

There is some minor tweaks that need to be introduced but I dont want to muddy the water. One is that productivity rates would factor into this and periods of high productivity could sustain higher interest rates (or cause lower inflation at the same rates).



So ..... the base rate of the banking system sets the rate of inflation...... feel free to highlight my many errors

westernpromise

High interest rates suppress inflation by taking demand out of the economy so the effect is the opposite of what you postulate.

cells

westernpromise wrote: »

High interest rates suppress inflation by taking demand out of the economy so the effect is the opposite of what you postulate.

I think the link is fairly weak for that if it exists much at all, else with rates at 0 for many years now we would expect the world to be in its biggest boom yet demand is weak...

so....high interest rates cause high inflation so that nominal returns are kept at sustainable levels.... is still a possibility until someone can find some holes in the idea

If the central banks put up rates up there has to be some signals or ways that the market participants influence inflation. My thoughts while half asleep are that the debtors (like yourself, or the government) and the savers (like whoever has cash in the bank and whoever buys gilts have an agreement whereby the real burden of the debt must be sustainable else the system simply doesn't work and all lose out. So if we take the crazy example of the BOE putting rates up to 20% over the next 2 years there are two options. 1 you and the government and the banking system go bankrupt and the lenders/depositors get screwed just as much as you. 2. you and the lenders /depositors agree inflation needs to be higher to have a more sustainable real interest rate to save all your bacons. I think 2 would play out its in everyone interest but I cant quite find the mechanisms that would transmit this information and put into place this agreement

antrobus

cells wrote: »

...So ..... the base rate of the banking system sets the rate of inflation...... feel free to highlight my many errors

Why bother? Isn't it easier to simply accept that every economist since Adam Smith was wrong, and that some Random Guy off the interweb is right.

cells

antrobus wrote: »

Why bother? Isn't it easier to simply accept that every economist since Adam Smith was wrong, and that some Random Guy off the interweb is right.

Problem with that is that if inflation was reasonably well understood it could be controlled yet there seems to be little to no control of inflation or even predictability of what inflation will be a few years out. So to claim every economists is against me so they are right completely misses the point that none of them has even a realible way to predict inflation a few years out let alone an all knowing understand of it.

Of course the right way to know would be to run an experiment put up rates by 5 points and observe inflation over the next 5 years. But none of the big advanced economies are willing to run experiments on their economies for good reason.