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So, is it possible that the fed will never raise rates?
Just a clarification here: the Fed does not have total, or direct, control over any and all interest rates. It can influence them--quite a bit. But it is not completely omnipotent.
The Federal Reserve directly controls two interest rates: the Federal Funds Rate and the Discount Rate. Explaining what those are would take another post...
If bondholders start selling bonds, then interest rates rise regardless of the Federal Reserve. The Fed could counter this process by buying them up--a process called "monetization", but not without significant consequences (inflation).
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If so, will this eventually lead to deflation or inflation?
It can go either way, depending on what the Federal Reserve does. If it monetizes too much debt, then that is inflationary.
That is a common pattern in third world countries, but it is less common in bigger, more "advanced" economies. That's because hyperinflation sucks way more than "deflation": prices have a lower bound. THEY HAVE NO UPPER BOUND. The more common pattern in the USA, Europe, and Japan is this:
When the amount of debt in an economy is growing dangerously large, as it is at the moment, eventually there comes a time when economic growth is too small to earn enough profit to service all the debt.
When that happens, more and more individuals, companies, and governments (in the USA, that would be mostly state and municipal debt--but outside USA it's whole countries) start defaulting on their debt payments.
Those of you who know something about radioactive decay: one atom splits, and knocks nuclear debris into the nuclei of other atoms, that split and repeat the process. If you hit the right threshold, it goes critical and starts an avalanching chain reaction.
If a company goes insolvent, then it's not paying off its creditors. If A can't pay B, then B can't pay C, then C can't pay D, and so on. The cascading defaults eventually go critical, so that they spread from one company to another to another to another. And some of those companies are banks and other financial institutions.
So, usually, "deflation" comes first.
The process can continue cleanly, with huge numbers of defaults happening rapidly, but that's not usually what happens either. Usually central banks organize bailouts, etc. Those are technically inflationary, but usually not on a big enough scale to overcome the avalanche of defaults.
Eventually, quickly or over a painfully long period of time (Japan, courtesy "Abenomics"), the bad debt gets written off, and resolved through bankruptcy, etc. The so-called "deflationary spiral" has an absolute lower bound. It can't go on forever, though government and central bank interference can keep it going indefinitely, unfortunately.
But what do you suppose happens as the debt runs out, but governments are running extremely inflationary policies?
The central banks can try to slow down the inflationary processes before they run out of debt, but it's a little like trying to change the course of a gigantic ship. There's a lot of momentum.
The result, when the debt to be resolved has been worked out of the system, is something called the "crackup boom". Severe inflation that could turn hyperinflationary if it gets out of control.
One more thing: most people tend to think of "inflation" as rising prices. But it's better to think of it in terms of rising amounts of money circulating in the system, along with rising "velocity" (the money is changing hands faster....think about it, if money is becoming worthless, nobody wants to be sitting on the "hot potato"!) Accelerating monetary velocity has the same effect as rising amounts of money in the system, and it produces a "feedback loop" (the expectation of inflation turns self-fulfilling, as monetary velocity starts accelerating), which is one of the causes of "runaway inflation" that can turn into "hyperinflation".
Now then, if people think of "inflation" as rising prices, they might also be tempted to think of "deflation" as falling prices. THAT IS NOT THE CASE.
Whether prices rise or fall during "deflations" depends on
- whether the item to be bought and sold is typically bought using debt or cash
- how illiquid the asset becomes
During recessions, people still want to eat. The cost of living can and often does continue RISING, not falling!
What tends to fall in price are "investment assets" and "use assets" (houses...pleasure boats...vacation homes...etc). How fast and how much depends on various factors that would take a while to explain. Just assume that the stock market and bond markets can crash rather suddenly, which is why I suggested someone who wanted to know how to get into the stock market to learn about business cycles (and credit cycles) first.
Similarly, during inflations, not all prices rise equally fast! This is important to understand:
- Companies can go bankrupt even as they report rising profits every quarter! It's weird but true. What happens is they don't discount their profits to account for inflation, so they book phantom profits and one day go insolvent as they are unable to keep up with rising costs of inventory replacement! You can simulate how it works with a piece of scratch paper, or on a computer program or spreadsheet.
- They not only can, they do. Company bankruptcies actually ACCELERATE during steep inflation.
- You can also lose money or even go broke with phantom profits in use assets or investment assets. The stock price goes up...but not as fast as prices in general! You're actually LOSING purchasing power, but being taxed on a bogus capital gain. This is called a "stealth bear market".
In a "deflation", the trick is not to lose money. In an inflation, the trick is to lose as little purchasing power as possible, though effectively it is practically impossible not to lose some due to being taxed on bogus capital gains, not to mention, losing purchasing power on all the cash you need to keep in reserve to stay solvent. That's why inflation really sucks.
Does this explanation make sense to you? Is it clear enough?