Does inflation compensate high interest rates?

Discussion in 'Economics' started by mattecheverria, Nov 21, 2012.

  1. I am currently living in Argentina where inflation is running at about 25% PA and interest rates for personal borrowing are running at between 20% and 35% (fixed).

    In the UK, inflation is running at about 2.7% and interest rates for personal borrowing are about 4%.

    I have heard people say that although the interest rates are very high in Argentina, the inflation has an effect on the interest which makes them almost as good as the 4% rates in the uk.

    What I really want to know is if I'm any worse off than someone in the UK, for example. Here's my reasoning's - workings attached. Lets take a property worth 1 million Argentine pesos.

    In Argentina with inflation at 24%, the "value" of this property in 10 years would be 8.6 million pesos, if inflation continues at 24%. If I was to borrow 1 million pesos on a 30% fixed interest rate, payable over 10 years, the total repayments (capital + interest) would be 3.1 million pesos.

    In the UK, lets keep using pesos as a currency, at 2.7% inflation, the 1 million property will be worth 1.3 million pesos, and the cost of the loan at 4% interest, as per above, would be 1.2 million pesos.

    Is the Argentine scenario then not a better one (all things considering!) where I end up with a property worth 8.6 million, at a total cost of 3.1 million, compared to the UK, where I would end up with a property worth 1.3 million, compared to my 1.2 million investment?

    Leaving fluctuations in land value aside, which is often not only an economical consideration, what pit falls could I come across? Or is my perspective of this totally warped?
     
  2. inflation = fake currency (circulated by your govt)
     
  3. Your numbers seem right, but the actual outcome will depend on whether all things increase in price at the same rate.

    Could be that food moves at the inflation rate, but property does not. Or any combination in between.

    I could say, that whenever you're borrowing at one rate, to earn another rate, it's a punt on that differential continuing to remain your way.

    A more interesting question may be about the rental yield you could earn. Lock in the interest rate on one end, against a tenant's lease on the other?
     
  4. 2rosy

    2rosy

    you're numbers show that argentina has negative real rates and the UK positive real rates. you're getting paid to borrow in argentina; so borrow...use that money to borrow...use that money to borrow :cool:
     
  5. If the rate of inflation is high is it easier to pay debts back because the amount depreciates in real terms. However inflation is bad for the economy because it deters foreign investment, which is the real thing that makes an economy take off. You personally might do better with it if you owe money. But the economy as a whole will suffer in the long term.
     
  6. Actually, it makes if harder if the rate you're paying is above inflation. Positive vs negative real, as per 2rosy, makes all the difference.