Inflation and the nominal interest rate When the actual and expected (or anticipated) inflation rates are both zero, the money interest rate must equal the real interest rate. How might inflation affect the money interest rate

Inflation affect the money interest rate by the fact that as interest rates are reduced, more people are able to borrow more money. The result is that consumers have more money to spend, causing the economy to grow and inflation to increase. The opposite holds true for rising interest rates.

Conversely, Many economic egg heads in Economics claimed that interest rates will rise if present monetary policy produces inflation. But the principle of supply and demand suggests that if money is plentiful, its cost — i.e. interest rates — should decrease. Thus any rise in interest rates would be the result of fiscal policy to fight inflation and not just because of inflation, right? Hope you can straighten me out without using “stagflation.”

Explanation:

However, which of the school of thought should you align yourself with?

Considering further analysis on this matter, let us also examine this analogy, thus:

What is Inflation?

Inflation is the rate at which the general level of prices for goods and services rises. As for price increase, this leads to falling in the purchasing power of the currency. It is very much necessary to keep inflation rate within permissible limits for the smooth functioning of an economy.

Let us understand inflation with example- Suppose in 2018 a man buys petrol daily ₦1000 for his car and price of one liter was ₦ 100, in ₦1000 he gets 10 Litres of petrol and now, if he buys petrol of ₦150 considering the current rate of petrol per liter, he will get 6.7 Litres of petrol. Although ₦150 remains the same its purchasing power decreased by 2 years earlier, he gets 10 L petrol at the same price as of today’s 6.7 L of petrol. This is called inflation.

What is Interest Rate?

The interest rate is the rate at which the lender is lending funds to the borrower. The interest rate has a vital impact on the economy of the country and has a major impact on stock and other investments.

The interest rate is decided by considering two factors.

Capital availability, if a rate of interest is high then capital is costly.

If the rate of interest is low, bank customers will not get sufficient return on their fund which will demotivate customers to keep the amount in the bank, as a result, the bank will not have funds.

If money is cheap, people will get the motivation to get money in the market and as a result, the value of money will decrease. This will increase inflation.  The rate of interest for loans and deposit are different. The rate of interest for loans are high whereas for deposits comparatively less. The interest rate is a price for holding or loaning money i.e. price for depositing or borrowing of money.

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