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Inflation and interest rate

Although I didn’t major in Economics I do manage to understand some of its theories.

One thing I find interesting to post about is the relationship between inflation and interest rate.

In simple terms, interest rate is the economy way of knowing how much money costs.
When inflation is rising countries (or regions) normally rise the interest rate of reference. Why?

  1. Existing loans cost more to pay (the interest is larger), so families’ and companies’ available budget is reduced.
  2. As there’s less available money there will be less demand.
  3. Less demand means that sellers will have to decrease prices, or at least increase them slower.
  4. Sellers will sell less, which would lead us to 2. again.
  5. Prices rise slower, therefore inflation decreases.
  6. For a more extensive approach (and accurate), visit this Bank of England education article.

Última actualização: 08/06/2012

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