Interest rate and Inflation

Why do they care so much, why should you?

You must have been hearing that the Federal Reserve, national banks, or “Banks” have reduced or increased the interest rate. Have you ever wondered why people care about this and why you should?

Let's just start from the basics.

We deposit the money in the bank that provides the highest interest rate, and if we want to take a loan, we search to get a loan with the lowest interest rate possible.

If you think about it and think about the major chunk of the population will be affected if National banks decrease the rate of interest, which leads to a rise in consumption in the economy as there will be people who tend to get loans at a lower rate of interest now, and people tend to deposit less money in the bank as they will be getting less interest on the money.

If you are someone who is kinda into economics you will say  “Bro, what about the government expenditure, and what about the demographic of the country, what if people do not wanna spend the money as they see the warning of some wars, etc,” to be honest I agree with you there are many other factors which can influence in the consumption in the economy but in majorly this is a norm which you can follow to understand why banks change the interest rate to regulate the inflation.

We can see that there is an inverse relation between the interest rate and consumption in the economy.

When a National bank raises the rate of interest rate, it decreases consumption in the economy which means there is less demand in the market which decreases the prices of goods and services, that's how they regulate the inflation.

You will be like “I got it bro, but why do banks just decrease the inflation more than or end it, I would say they can because you need the inflation to exist at about 2% otherwise will be other crises or issues in the economy since if you decrease the inflation to 0 or less than zero it will be lead to deflation which means prices are so lower it will affect the income of the people since people are earning less from the business or economic activities.

There are situations in which these methods won’t work like in Argentina where interest rate and inflation rate were both shooting up, The New Govt decreased the govt expenditure to decrease money in the economy.

There is also Japan where the interest rates were negative but people were not spending enough to run the economy which led to a decrease in the prices of services for 25 years.

An increase in interest rate will lead to a decrease in prices because there is less demand which decreases the prices in many things.

Prices fell in Japan in the 1990s even though they made the interest rate negative, but it didn’t increase consumption because of the demography of the country. Consumption has also stayed low because of declining fertility and marriage rates.