Understanding Interest and Inflation
The Federal Reserve has been raising interest rates to crush inflation. What does this even mean?
As you read this explanation, keep an eye out for two words: interest and inflation.
Suppose you decide to borrow $300 from a bank to purchase a Nintendo switch. The bank will charge you a certain amount of money for borrowing the $300, and that extra amount of money is called “interest.” The higher the interest rate is, the more money you will have to pay back to the bank.
For example, if the interest rate is 10% and you borrow $300, you will have to pay back $330 total to the bank. This is because you will owe them the original $300 that you borrowed, plus 10% interest on that $300, which is $30.
Now suppose that there are only 10 Nintendo Switches available to be sold. If the interest rate is low, then more people will want to borrow money to buy the Switches because they can afford to pay back the loan. The higher demand for Switches will drive the price up.
This may happen with all sorts of products, such as laptops, furniture, and even houses! When the prices of all things start to go up, this is called inflation.
When the government sees inflation happening, it usually responds by increasing the interest rates.
When the interest rate is high, then fewer people will want to borrow money to buy the Switches because they will have to use most of their money just to pay back the loan. The lower demand for Switches will drive the price down.
The Fed has lifted interest rates five times this year, which is why you hear a lot about how the economy is doing and how the market will react.
