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By Ashton Asherian, Co-Founder and Principal
Inflation and rising interest rates often go hand-in-hand, but their connection is not always clearly understood. This article aims to provide a comprehensive understanding of the relationship between inflation and interest rates, shedding light on the key concepts, driving factors, measurement methods, and the impact on various stakeholders. By unraveling these dynamics, investors, particularly those involved in commercial real estate, can make informed decisions.
Inflation is defined as the increase in prices for goods and services within an economy. It signifies declining purchasing power over time. When a country's gross domestic product (GDP) rises, indicating economic growth, the demand for goods and services increases as well. This surge in demand leads to higher prices, causing inflation. However, excessively high inflation can erode savings and create economic instability, while low inflation can result in deflation, hindering business profitability and consumer spending.
Inflation is driven by several factors, primarily an imbalance between economic supply and demand. It is not merely a result of price fluctuations in specific goods or services but a macroeconomic issue that encompasses aggregate demand and supply across various sectors. The three main drivers of inflation are demand-pull inflation, cost-push inflation, and built-in inflation. Demand-pull inflation occurs when increased consumer spending leads to higher demand for goods and services, pushing prices upward. Cost-push inflation arises when production costs, such as raw materials or labor, increase, and businesses pass these costs on to consumers. Built-in inflation occurs when workers demand higher wages to keep up with rising living costs, thereby fueling further inflation.
Various government indexes track prices to measure inflation. In the United States, the most commonly referenced index is the Consumer Price Index (CPI), maintained by the Bureau of Labor Statistics. The CPI uses a "basket of goods" that represents the overall economy, including items such as food, shelter, energy, autos, medical care, and home furnishings. The Federal Reserve focuses on core inflation, which excludes volatile factors like food and energy, to assess long-term price stability.
Price stability is a crucial aspect of a healthy economy, and the Federal Reserve plays a significant role in maintaining it. The central bank adjusts interest rates as a tool to regulate inflation. Interest rates are the charges imposed by lenders on borrowers for borrowing money. By raising or lowering its own interest rates, the Federal Reserve influences the rates set by commercial banks and other lenders. When the Fed raises interest rates, borrowing becomes more expensive, leading to decreased demand and eventual price stabilization.
In an inflationary environment, certain groups are more affected than others. Those on fixed incomes and low-wage earners experience the greatest challenges, as their purchasing power diminishes. Stocks can be negatively impacted in the short term due to decreased consumer spending and reduced investment demand. However, investments in tangible assets like real estate tend to hold their value and even increase with inflation, making them attractive options. Borrowers with floating rate debts may face higher interest payments, while lenders holding floating rate bonds can benefit from increased returns during periods of volatility.
While inflation and rising interest rates can be concerning, understanding their dynamics and implications can provide opportunities for investors. Inflation, driven by an imbalance in supply and demand, can erode savings and create economic instability. The Federal Reserve's adjustment of interest rates aims to maintain price stability and control inflation.
Rockview Capital (“Rockview”) is a private equity firm focused on making strategic, long-term investments in multifamily real estate across the United States.Rockview leverages its deep network of private investors and family offices to capitalize on lucrative opportunities across the multifamily sector, whether through direct acquisitions or co-investment structures.
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