9.1.2.1. Inflation and Interest Rates
Inflation can result when demand for goods and services outstrips their supply. This usually occurs near the end of an expansionary phase, when too much money is chasing too few goods. Inflation can occur because of:
• High consumer confidence in the economy
• An economy that has reached its production potential
• Excess money in the economy
• Increases in wages and other production costs
With rising prices come rising interest rates; if the cost of living is increasing at 5%, as measured by the Consumer Price Index, investors will be unwilling to purchase a bond at 4% and lose purchasing power. Lenders will need to raise interest rates to keep in line with inflation.
Investor
