CONNECTION OF INFLATION AND INTEREST RATES
We cannot simply ignore the connectivity of inflation and interest rates. Both items are interrelated. So, whenever there is a news item about a country’s inflation rate, traders and speculators, even the government and the general public, anticipate a central bank’s decision on interest rates.
Who decides on interest rates? Like what was mentioned before, the central bank. Some of the world’s major central banks include the Federal Reserve (in the United States), the European Central Bank (eurozone), the Bank of England (the United Kingdom), and the Bank of Japan (Japan).
The Fed officials meet eight times a year to determine interest rate targets. Therefore, whenever they hold a meeting, the US central bank trails CPI and PPIs to figure out whether to raise or reduce rates, as well as the monetary policy (or policies) to be implemented to spur growth.
Interest rates directly influence the credit market (in other words, loans). The higher the rates, the higher the borrowing cost. Central banks exert all efforts to attain maximum employment level, feasible level growth, and steady prices. As interest rates decline, consumer spending escalates; hence, fuelling economic growth. Conversely, as rates increase, spending slumps.
There is such thing as excessive economic growth, but it can severely affect a nation. An economy growing too fast can experience hyperinflation. On the other hand, an economy with no inflation sustains stagnation. The pressure to retain the balance, the right level of economic progression and inflation, is placed on the central bank. If they want to fend off inflation, they tighten or increase rates. To ignite economic growth, they ease or decline rates.
Inflation is the primary factor considered in increasing or decreasing interest rates. However, there are other factors that can impact the central bank’s decision-making. A central bank may opt to alleviate rates in times of financial crisis to provide liquidity to their financial market; hence, to topple economic degeneration.
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