How does inflation affect interest rates?


Quick Answer

As inflation occurs, the central bank is able to adjust interest rates, thus encouraging economic growth. Without adjusted interest rates, there would be little growth during times of inflation as people's purchasing power becomes less. When interest rates are lowered, people are able to continue to purchase regardless of the fact that the purchasing power has lessened.

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How does inflation affect interest rates?
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Full Answer

Inflation is a sustained increase in the price level of goods and services. This can result in both negative and positive effects. A positive effect is that, in the United States, central banks are able to adjust interest rates and decrease the chance of a recession. As interest rates are adjusted to a lower rate, people are more likely to invest and purchase.

Interest rates directly affect the credit or loan market. High interest rates make borrowing costly. By changing interest rates, maximum employment, stable prices and a good level growth can be achieved.

Inflation is a sign of economic growth. In some situations little or no inflation can be as bad as high inflation. Little inflation can be a sign that a country's economy is weakening. While inflation does have a large impact on interest rates, it's not the only factor in the adjustment of these rates.

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