The most important price in the global economy is arguably the price of money. While the prices of commodities like oil, semiconductors, and even consumer goods like Big Macs have their significance, the price of money, which is reflected in interest rates, plays a fundamental role in shaping economic conditions. For over three decades, interest rates were on a declining trend, and now they are rising.
Many people attribute the setting of the price of money to central banks, and in the case of direct control of US interest rates, the Federal Reserve does indeed have a significant influence. However, there’s a more profound underlying principle at work. Essentially, the price of money, like the price of any other commodity or service, is determined by the balance of supply and demand. An increased supply of savings tends to drive interest rates down, while greater demand for investment tends to push them upward. This complex interplay of economic factors shapes the cost of borrowing and influences financial decisions on a global scale. The most important price
For the economics wonks, the price of money that balances saving and investment while keeping inflation stable has another name: the “natural rate of interest.” To see why this concept is central to policymaking, imagine what would happen if the Fed set borrowing costs well below the natural rate. With money too cheap, there would be too much investment, not enough saving, and the economy would overheat—resulting in spiraling inflation. Flipping that around, if the Fed set borrowing costs above the natural rate, there would be too much saving, not enough investment, and the economy would cool—resulting in rising unemployment.