Relationship between Inflation and Interest rate

Inflation is rise of prices of goods and services gradually overtime.

Interest is a major factor that impacts inflation rate. Today I am going to discuss various phases an economy faces to stabalize the prices.

Effect of Interest rate on Inflation

Phase I

Demand is very low in the economy, unempoyment rate is high. Government has two solutions, 1) Increase production level or 2) Decrease interest rate

Phase II

Short terms solution is decrease in interest rate. Now people will get loans at lower rate of inetert. This will give a short term booster to economy.

Phase III

As there are limited resources and people have infinite demands. People in the economy started purchaing more than production levels. Everybody started fulfilling their needs using funds from loans. This leads to high inflation rate

Phase IV

Inflation makes a direct impact on poor people in the economy. Now government is looking for ways to decrase the inflation rate. Interest rate is increased is increased, now people borrow less and demand level decreases.