Inflation

The number of dollars in circulation exceeds the amount of goods and services available for purchase; inflation results in a decrease in the dollars value.

Interest rates are partially driven by economists' and investors' expectations about inflation. If they project higher inflation, then they will demand higher returns on investments to counteract it, thereby increasing interest rates. If inflation is expected to be low, then lower rates will prevail.

One of the biggest causes of inflation is having too much money in the economy. Lowering rates increases the borrowing power of banks, companies, and individuals. Raising the rates forces people to spend less and borrow less. The effect of the higher rate is a reduction of money in the economy.

As inflation gets out of control the price of goods increases. This means a loaf of bread that cost 2 bucks last month might cost 4 bucks this month. When inflation occurs prices rise.

Inflation is one of many indicators to watch when trying to determin what will happen with future interest rates.

Somewhat controlled by the Producer Price Index and the Consumer Price Index, inflation indicates the general trend of an increase in the cost of goods and services in a economy. These factors are what contributes to the fluctuations in mortgage interest rates.

The Federal Reserve Board which you may hear called the FED controls interest rates to combat inflation or stimulate the economy. The reason we have seen all time lows over the last few years is because of some major events that happened. We had the Y-2K scare along with 9/11 and the stock market crash all happening rather close together. The FED lowered rates each time to stimulate the economy. When rates are low real esate sales and values are up but there is a problem with inflation getting out of control when this happens. So the rates are always adjusting for this.

One of the reasons interest rates were so high in the 1980's was that investors felt that inflation was out of control. Think of it this way, investors lend today's money and get paid back with tommorrow's money. If inflation was 12% per year investors would need to have at least that amount as an interest rate just to break even.