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Inflation & Interest Rates Question?

Discussion in 'Business studies' started by Boathoss, Feb 15, 2011.

  1. Hi,
    Hopefully someone can help.

    After todays news about inlfation rising can anyone explain to me why interest rates should rise? Surely this will mean people save more money as the increase gives them a bigger incentive to save and things like mortgages will become more expensive (e.g. tracker mortgage).
    This will reduce demand for goods and reduce the flow of money in the economy, does this mean that suppliers of goods will have unsold goods and therefore holistically will have to reduce prices (i.e. Inflation Reduces).
    Surely we want more demand in the economy, please can someone help.

  2. In theory, if interest rates are increased, people will have less disposable income due to higher debt repayments on things like mortgages & credit cards. They will therefore spend less money, reducing demand and this should control inflation.
    The problem at the moment is that inflation is not being caused by 'demand pull' factors but by rises in VAT, fuel prices, food prices etc. Therefore, if interest rates are increased, people's incomes will be squeezed further (already tough due to wage freezes etc) yet it probably won't have the desired effect on inflation.
    That's my theory / view of it anyway, I'd welcome any others!
  3. Thanks for that.

    Does this reduction demand then mean that the economy is then presented with Excess supply, as people aren't consuming goods. As such if prices remain the same and constant then they will be left with unsold goods. And that the only way to combat this is to reduce prices overall (inflation reduces) to make products more affordable?

    I see how it controls spending however is the obvious answer the one i have presented above, prices through market forces fall due to reduction in demand. Just like the basic theory of demand and supply.

    So so economist suggest increasing interest rates will hamper inflation and then eventually reduce it back to the target of 2.0?

    Any more support would be brilliant.

    Thanks once again.
  4. Also, A rise in interest rate will also improve the strength of the £, therefore imports will become cheaper reducing cost push pressures.
  5. So if interest rates rise this hopefully caused Aggregate demand to reduce. This reduction leaves excess supply within the economy and market forces dicatate that prices (inflation) will reduce to a more suitable level....thus bringing down inflation....is this correct?


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