Reply To: Fed Tapering and Interest Rates


Arbitrage brings all interest returns together as far as possible given differences among different types of investments, including uncertainty and maturity.

Monetary inflation through credit expansion has a two-fold effect on interest rates. The credit expansion increases the supply of credit which pushes interest rates lower. The monetary inflation reduces the purchasing power of money which pushes interest rates higher. These basic effects of monetary inflation and credit expansion on interest rates is complicated by changes in demand for credit and demand for money. For example, monetary inflation during the 1970s generated double-digit price inflation, in part, because money demand was falling while monetary inflation of similar magnitude recently has generated little price inflation, in part, because money demand has been rising.