How Does Raising Interest Rates Help Inflation?

Have you ever wondered how the increase in interest rates can help inflation? If yes, then this article is for you because here, you will get to know how and why interest rates affect inflation either negatively or positively. 

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In theory, when the cost of borrowing money and loans is extremely expensive,  the demand will be low hence leading to a reduction in the supply of everyday goods. This scenario determines whether or not an economy will experience inflation. 

What Is Inflation? 

Inflation is an economic situation whereby there is an increase in the cost of production and the price of goods and services. 

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In other words, when an economy experiences inflation, there is always an obvious shift in the price of goods in the market from low to high. 

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People will have to pay more money to be able to afford or purchase a product, and companies will also have to increase the wages of employees to be able to retain them. 

Inflation is usually a drastic economic situation that can spike demand, leading to an increase in the prices of commodities. 

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Credit: Deccan Herald

Why Is Inflation High? 

There are many reasons why inflation is high, and such reasons should be considered in an economy to avoid being on the verge of an ugly economic situation. 

Inflation is determined by common factors such as an increase in the cost of production, reduction in workforce, unemployment, economic expansion, and an increase in the cost of goods. 

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When there is an abnormal increase in the cost of producing goods, the economy tends to suffer heavily from the effect because the price will eventually go up. 

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An increase in the cost of goods and services results from a rise in the cost of production. And both are two major effects that cause inflation to rise. 

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If not handled with immediate measures, the economy will continue to suffer. 

How Will Interest Rate Rises Affect Me? 

As a business owner or an entrepreneur, you can also be faced with the ugly situation of an increase in interest rate.  An increase in interest rates can be a stumbling block to any investor, business owner,  or entrepreneur. 

Let’s say, for example, you have a loan or a mortgage that usually changes to a variable interest rate, and suddenly the loan providers decide to increase the charges placed on their loans and mortgages. 

You will then find out that your repayment for the loan or mortgage has gone up, which can be very frustrating and disturbing. 

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How High Will Inflation Go? 

This is one of the most popular questions a lot of people ask related to inflation. How high inflation will go is unpredictable at the moment, and it all depends on whether or not things get worse than they are in present times. 

A bad economy will most likely experience inflation more than a good economy because demand will increase with price and little supply of goods, leading to instability. 

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If the economy experiences anything worse than its present situation, it should be prepared to face inflation. It may sometimes be temporary, but if things don’t sit well in the economy, then the situation may last. 

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What Happens When Interest Rates Rise? 

An increase in the interest rate affects a lot of things, and one such thing is that it is too expensive to borrow money. 

When the charges or interest added to loans becomes unfavorable and expensive, people find it difficult to borrow loans which in turn leads to low demand and high prices of commodities in the market. 

What Causes Interest Rates to rise? 

There are a lot of factors that are capable of causing it to rise, including an increase in the cost of living, an increase in the price of goods in the market, and a lack of workforce. 

These are some of the major causes of inflation. When there is an increase in the cost of living and the price of goods, companies who give out financial loans and mortgages tend to hike up their interest on loans. 

Hence, making borrowing loans for personal or business purposes reduces drastically. 

How Does Interest Rate Control Inflation 

When interest rates are high, demand reduces, and the prices of goods and services increase, but when interest rates are low, demand increases, and the prices of goods and services decrease. 

The theory is vice versa, and such determines whether or not the economy will face inflation in the prices of goods and services. 

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What Causes Inflation to rise? 

Inflation is caused by an abnormal increase in the cost of production wh. When producers have to spend more money in the process of carrying out the production of goods, then the economy is said to be experiencing inflation. 

Why Do Lower Interest Rates Increase Stock Prices? 

The simple explanation is that when interest rates appear affordable and friendly, people tend to borrow more money for their businesses and personal uses. 

In this case, the more money people borrow over a period may force the loan providers to increase the prices of stocks. 

The theory proves that demand is one of the core factors that affect supply, so, in a situation whereby there is an increase in demand, then there will be an increase in supply as well. 

Conclusion 

Inflation is a critical economic situation that tends to affect all sectors of the economy, and it is very important to know that some major factors are capable of causing inflation.

If the government can handle all the factors capable of causing inflation strategically, then most definitely, there would not be any case of a rise in interest. 

You can learn more from the video below:

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