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When To Borrow Money?

The Connection Between Inflation Rates And Interest Rates: When To Borrow Money

If you are having to decide when to borrow money, you need to look at the inflation and interest rates. Inflation rates and interest rates are closely connected. Rising inflation can make the dollars in your pocket today be worth less tomorrow. That's a good thing for borrowers having to pay back loans, but bad news for lenders.

Lenders realize that the dollars they will receive in repayment next month are worth less than those they loan out today. To compensate, lenders raise their rates of interest.

So, a nasty cycle is set in motion. As the cost of goods rises, consumers with limited cash on hand tend to borrow more money to purchase the goods they need or want, such as new cars, appliances, home improvements, and so on. Businesses also have to borrow money for new equipment and expansion.

This causes interest rates to increase further, as borrowed money is now in greater demand. Greater demand and a fixed supply cause prices to rise; the price (the interest paid) is the cost of the money borrowed. And the cost of goods and services increases (inflates) to compensate.

Inflation And Interest Rates

The chief cause of inflation rests firmly at the doorsteps of governments. Their high borrowing, deficit spending, issuing of credit, or actual currency printing directly affects the rise of interest rates and inflation.

There is very little you as a citizen can do to change the system other than press your elected representatives to implement sound economic policies or vote for a better government at election time. Often, the latter is more effective, so be sure to cast your vote.

As a borrower, though, you can and should take action to protect yourself. Smart governments don't allow inflation to keep on rising. If they did, inflation rates and interest rates would ultimately rise to a point where business and labor would angrily shout their demands to "do something" about it. Usually, "doing something" means lessening the money flow to slow or reverse the spiralling effects of inflation.

For borrowers, those slowing actions can have a marked effect. Deflation can lower interest rates and thereby foster more borrowing, but deflation also has its negative effect. It makes the dollars you borrow today be worth more tomorrow. So, when you repay the loan, it will end up costing you more. It's the time to hold onto money, not borrow it.

So, when deciding when to borrow money, you have to do as the banks do. You have to try to guess which way the economy is likely to go: inflation or deflation. It's a tough call even for the economists, so how can we as ordinary consumers make such a call with any degree of accuracy?

How To Forecast Interest Rates And Inflation

Really, there is no infallible method of forecasting interest rates and inflation, but we can use some of the same "indicators" that the banks and economists use. These indicators are freely observable by everyone.

The price of gold was once a very good indicator, but now that currencies are no longer tied to hard commodities, it's not useful. However, there are a couple of indicators worth watching.

Oil

One of these indicators is the price of oil. Oil is a basic commodity that is closely tied to transportation and the production of many goods. As the price of a barrel of oil rises, inflation is likely to increase. Watch the price of oil options and try to determine whether prices are expected to rise or decrease in the future. Television newscasts and the financial sections of newspapers often provide commodity forecasts.

Bonds

An increase in the price of bond options is another indicator. It often indicates that money managers are betting there will be a significant change in interest rates over the next twelve to twenty-four months. It's a complex relationship, though, and you should confirm your observations with a money specialist. Often, the investment manager at your local bank would be happy to give you his or her thoughts on the matter at no charge.

So, When To Borrow Money?

Consider the actual cost of your loan. Remember, the dollars you have in your pocket today are simply a measure of the cost of goods and services today, whereas tomorrow's dollars measure that cost tomorrow.

When you borrow money, you are purchasing dollars today that you will likely spend today, but you will have to pay them back to the lender in the future. Whatever those dollars are worth at the time you pay them back determines the actual cost of your loan.

When deciding when to borrow money, keep in mind the connection between the interest rate and inflation, and you will stand less chance of getting beat up by the economy.

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