From The School of Life blog by the author of How To Speak Money, here are a couple of useful definitions: interest rates and real and nominal amounts (also related to interest rates). Helpful and funny too …
interest rates If I had to pick one term which summed up my reason for wanting to write this book, it would be interest rates. I must have heard interest rates mentioned in the news thousands of times before I found out why they were so important. When the financially literate talk about interest rates, they’re bringing to bear a whole set of linked ideas about inflation, unemployment, the cost of borrowing, the exchange rate, the political impact of rising mortgages, the conditions of trade for business, the price of exports, the balance of payments and the growth or contraction of the economy – all packed into two words, ‘interest rates’. Blink, and all the ideas packed into these two words have gone zooming past. To people who don’t speak finance, the language can seem impenetrable and the interlocking ideas too complex to grasp or unpack at the necessary speed.
The reason interest rates matter so much is because the interest rate is the cost of money at any given moment. It’s also the rate at which it is possible to invest risk-free, because you can buy a government bond at the prevalent interest rate, and it’s guaranteed to pay you back. This means that when interest rates go up:
1. life is harder for businesses, because money is more expensive, and
2. people will tend not to invest in companies, preferring to invest in risk-free bonds, and
3. the stock market will fall for that reason, so
4. confidence in general will fall. In addition,
5. people with mortgages will find it harder to make their repayments, and those who are coming off fixed-rate deals may suddenly have a dramatic increase in their monthly repayments. That means
6. mortgage defaults will rise, so
7. there will be downward pressure on house prices, and
8. some people will be in negative equity, which will stop them spending money. Also,
9. the currency will rise, because higher guaranteed rates of investment will attract money into buying the country’s debt, so
10. life will become harder for manufacturing businesses, because their exports will be more expensive. Not only that, but
11. inflation will fall – remember, inflation means that money is worth less, whereas a rise in interest rates means that money is more expensive.
There’s more, too, but these eleven things are a starting point for all the things that are completely taken for granted by people who speak money when they hear ‘interest rates’.
real and nominal amounts Figures that, respectively, do and don’t take into account the effect of inflation. Because of inflation, all charts which reflect prices will go up over time; strip out the effect of inflation, and the charts can look very different. Take the example of the most profitable US movies ever made. (I’ve done it for the US because I can’t find a global version of the list adjusted for inflation.) On the left is how the chart looks if you just consider the sums of money in real terms, and on the right is the chart in nominal money (the figure in brackets is the placing on the real-money chart):
1. Gone with the Wind 1. Avatar (14)
2. Star Wars 2. Titanic (5)
3. The Sound of Music 3. Marvel’s The Avengers (27)
4. E.T.: The Extra-Terrestrial 4. The Dark Knight (29)
5. Titanic 5. Star Wars: Episode 1 (17)
6. The Ten Commandments 6. Star Wars (2)
7. Jaws 7. The Dark Knight Rises (63)
8. Doctor Zhivago 8. Shrek 2 (32)
9. The Exorcist 9. E.T.: The Extra-Terrestrial (4)
10. Snow White 10. Pirates of the Caribbean: Dead Man’s Chest (94)
Note how movies have got worse: on the nominal, and therefore more recent, list, seven of the films are franchises, one is based on a theme-park ride, and the top two are by James Cameron.