Does decreasing the interest rate cause a decrease in inflation?

Expert Answers
pohnpei397 eNotes educator| Certified Educator

In general, decreasing the interest rates charged by a central bank leads not to less inflation but to more.  A central bank tends to decrease interest rates when it needs to stimulate the economy and it tends to increase interest rates when it is trying to decrease inflation.

When a central bank lowers interest rates, it becomes easier for people and businesses to borrow money from banks.  This increases the money supply and it increases the amount of economic activity that is going on in the economy.  When these things happen, the price level will (all other things being equal) go up.

So, decreasing interest rates does not tend to decrease inflation.  An increase in interest rates is usually used to try to control inflation.

nikasho0100 | Student

A decrease in interest rates would not lower the inflation rates but make it worst as increasing interest rates would mean people are now reluctant to save as they would get a lower return for what they invested therefore people spend more with the money they have.As interest rates are lower people tenb to burrow more and spend and thus increases the inflation rate in a country.

Therefore increase in interest rates would mean high money supply in the ccountry and thereby increase the Aggregate Demand I(Total demand) in the country.

Therefore reduction in the interest rates or known as monetary policy would not reduce inflation but make it much worster than what it was.