How Inflation Affects Interest Rates In Any Country
As the people spend less the demand of commodities will decrease and there by the inflation will decrease. IN another way we can say that lowering of interest rate causes liquidity that is people withdraw their money from the bank and banks used to flow the money to the consumer in in lower interest which causes the increase of inflation and the banks have low profit which means low income that is the crisis on money. This is how inflation affects the interest rate.
Inflation, often misunderstood as a bad thing in the process of economy, represents the rise of the prices of goods over time and also the services and it is usually measured as a percentage. But without inflation, and interest rates as another weight on the scale, there is no functioning of the economy. So when it comes the dependency of both, they highly depend on each other and as much as interest rates impacts the inflation, the same effect inflation would make on interest rates. So, the interest rate is the cost when borrowing money.
Borrower pays a small interest so he or she could be given an ability to spend money now and as an inflation, it is expressed as a percentage rate. The factor that makes loans that are long-termed less wanted to lenders and as the proper answer rises the interest rate is the inflation. Long term loans have higher interest rates so when economy grows the rise of inflation makes the interest rates to go lower, which makes less borrowing power in the community and therefore slows the economy. When economy is rising a lot and country want to lower its growth and inflation, in order to do that they rise interest rates which slows the amount of money which enters economy.
As we know Inflation have closely related with the interest rate, most of time when inflation goes up the interest rate is also increased. It is just to provide equilibrium between supply of money and goods or service produced.
The interest rates is nothing but "cost of the capital" .The the capital provider who sacrifice the time value of money on a given amount and for a given period which is under consideration,that may be for short term or long term, i.e, interest rate. Moreover, in the present market definition, the interest rate is combination of followings:
1.Risk Free Interest
2.Market premium for risk and inflation.
The rate of interest is vary according to different financial plans and products of different financial institutions in the market . however, there should be govt. regulation and control over these rates to maintain a proper balance in economic growth of an economy.
The inflation arise when the supply of money exceeds the rate of production of commodity and services as a result the money loses its purchasing power. The price of goods and services are keep raising until there is liquidity in the market begins to drop. At that time,Interest rate must move up words to maintain the value money according to inflation and this can be properly regulated by the Govt. or any specific authority in the area which rise the interest rate to limits the supply of money in to market.
Due to Inflation the real value of money keep decreasing so the higher interest rate provides a healer mechanism towards the present value of money of a given sum to maintain its worthiness.