The current Federal Reserve Board, the group that sets interest rates, has a history of worrying about inflation as well as recession. It will not hesitate to raise rates quickly if it believes inflation is on the way. It is worth noting the detrimental effect of inflation on mortgages and the real estate market in general.
There are two basic reasons for inflation.
1. The first reason is if the economy is booming. Companies are expanding and competing for workers by offering higher salaries. The jobless rate is very low. Since more people are working for high wages, they buy more things, such as cars, appliances, and clothes. This higher demand causes higher prices (inflation). To keep the inflation rate under control, interest rates are increased. This causes less expansion and spending, lowering the demand for both workers and products.
2. The second reason for inflation is if the economy is slow but prices of goods are rising. Oil prices, for example, may be high. If oil prices stay high for a sustained period, it costs more for companies to produce products and offer services. This results in lower profits and, eventually, losses. The companies first try to increase productivity by closing unprofitable factories, retail stores, etc., which causes layoffs. They also reduce workers’ benefits and attempt to negotiate pay cuts with unions. Once it is no longer possible to fight the rising costs by increased productivity, they pass the increased costs on to the consumer. Since there are fewer jobs and lower wages, there is less demand for products and services.
Even though demand is lessened, prices do not fall because of the higher production costs. Interest rates go up to further add to the problem. The result is a lower standard of living until a solution is found to resolve what is keeping production costs, and thus, prices, high.