what is a relation between inflation and interest rate? Does interest rate depends on inflation or otherwise?

Question

As in the case of England inflation rate is even below the governement targeted rate of 2% at the same time interest rate has been increased 4 times

As in the case of England inflation rate is even below the governement targeted rate of 2% at the same time interest rate has been increased 4 times on the other hand if we take the example of India where there is quite high inflation rate but loans are also available in higher interest rate???

Answer 1

Inflation is a persistent increase in a general price levels.

Yes indeed, Interest rate depends on inflation. Actually, there is a negative relationship between both of them.

Three/four months ago the inflation rate was raised upto 3.1% and to control inflation rate government has increase the interest rate to 5.7% and consequently, inflation dropped to 2.7%.( Increase in interest rate, decrease in inflation rate. negative relation.)

This is also true that inflation rate is undercontrol but still interest rates are increasing steadily becasue it is pridicted that inflation rate might increase.

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Answer 2

I think it is important to simplify this as much as possible.

Imagine no government. If you are a banker and expect inflation, you will incorporate that into what you charge. So, if you were going to charge 3%, and you think inflation will be 3%, you will charge 6%. Hence, there is a positive relation between inflation and interest rate.

Now, imagine an economy with a government. The government actually tries to reduce inflation by charging banks for overnight loans it holds (the discount rate, which is a type of interest rate) or by selling bonds (which reduces the private money supply). In any case, a banker will have to incorporate this cost if it loans money and hence raise the money it charges for loans. So, you could argue that this policy will lead to a positive correlation with inflation. But it gets to be very complicated as the high rates reduce output, and government may change its policy at any time.

Answer 3

there is a postive correlation between the inflation rate and the interest rate, but to be more exact, it is the EXPECTED rate of inflation that affects the interest rate, and it can be different from the prevailing inflation rate. As to your quesiton, it is not clear wether you are refering to the general market interest rate (which is usualy benchmarked by the current yield of long term, e.g. 10 year, government bond) or the overnight/short term loan rate of central bank of england. It sounds to me that u are talking about the latter, which gets the most media coverage anyway. If indeed it's the latter case, then the rising rate simply means the england central bank is trying to slow the expansion of money supply (i'm not going to expound on that simply because it will get complicated), and therefore to deter the possible rise in inflation in the future. Anyway, all you need to know is that the rate set by the central bank is only a tool to manage the macroeconomy (it is not even the most potent tool!), and it usually is different from the general/market interest rate, which is the rate that truely affects most of the borrowers/lenders.

Answer 4

Inflation means that the value of money is dropping which means that when banks want to loan money they have to increase their interest rates because the money loaners will pay back money which will be worth less. So banks try to match the inflation rate so they don't lose money.

It's much, much more complicated than that though.

Answer 5

Which interest rate? (Risk-free) interest rate on government bonds generally changes in sync with inflation (so it's really hard to say which is causing which), while other interest rates are driven by both rick-free interest rate and the default spread over it, which is the function of expected default rate and expected loss given default. The interest rate you seem to be talking about is the discount rate (the rate at which the central bank lends overnight to major commercial banks); it has been repeatedly shown to follow the interest rate on short-term government paper...