In macroeconomics, interest rate and inflation are among the most crucial issues, studies not only by scholars but the general public, which allows them to see and understand global trends. While it might seem to someone that interest rate and inflation are two separate phenomena, they are immensely connected. In this case, it is valuable to analyze inflation in the context of interest rates and vice versa, considering that one influences the other.
Before, I did not see the causal relationships between the two, despite being aware of the characteristics and nature of both. However, in reality, they have power over each other and are inversely related (Farahvash, 2020). For example, a high interest rate will eventually lead to decreasing inflation. At the same time, since interest rates are the main instrument employed by the Federal Reserve to regulate rising prices, inflation and interest rates frequently change in the same direction.
The chain of events starts with consumer behavior and lower interest rates, which contribute to the borrowing of cheaper money. At this stage, inflation is low, and the authorities need the stimulation of the economy (Farahvash, 2020). However, with increased borrowing and purchases, inflation increases as well since too much money chases too few goods (Farahvash, 2020). As a result, in order to control inflation, the interest rate needs to be higher as well (Farahvash, 2020). Therefore, upon researching the topic of interest rates, I learned how it is intertwined with inflation. I saw that interest rates should be perceived as a tool to control consumer behavior since it is the driving force of inflation.
Hence, given that one affects the other, it is helpful to examine inflation in the context of interest rates and vice versa. Since too much money chases too few products, inflation rises along with rising borrowing and spending. As a result, raising the interest rate is also necessary to manage inflation. Thus, interest rates should be seen as a tool for controlling inflation and consumer spending.
Reference
Farahvash, P. (2020). Asset-liability and liquidity management. John Wiley & Sons.