How does interest rate affect inflation? Is it directly related or inversely related..
normally, increased interest rate wud mean than an individual wud earn more interest from his deposits/lendings…thereby circulatin more money and increasing inflation.
From another point of view..increased interest rate wud also mean that an individual would have to pay more interest on the money he borrows..thereby there will be less borrowing and less money circulation and thereby reducin inflation…
Which affect is more dominant ?
It is depend on bank policy for interest rate,
if rate is high, people will save more and these saving will be convert in investment. so the amount of rate will be less than the deposits and these deposits act as investment for borrower. higher investments leads to higher prices which is high inflation.
In reverse case, the rate will low , will also increase the expenditure/investment as the amount with people will higher, will lead the higher prices.
Actually when banks reduces lending schemes fr loan or say cease the bank loan facilities , increases the processing charges for loan on one side and on another side when bank increase rate for deposits and saving . In both cases the the amount increase with bank and reduces from public, so inflation rate reduces and in reverse case increases.
If rate of interest is high then people will save more in banks for getting high returns and further the money deposited by the depositors will be distributed by the bank in the form of loan for investment purposes this will lead to higher profit by both depositor and investors so they will demand more in economy then it will leads to high rate of inflation and if interest rate is less then it is vice-versa.
If rate of interest is high then people will demand less loans from banks this will lead to less investment in economy means less profit so inflation will be automatically corrected.