How do interest rates affect inflation?

Inflation is a general increase in prices across the economy. It is estimated with either the Retail Price Index (RPI) or the Consumer Price Index (CPI), which are calculated by adding together the prices of a selection of goods and services (exactly which ones differ in each index). Inflation occurs when demand (the amount of money being spent in the economy) exceeds supply (the goods and services produced by the economy); this creates competition for goods and services, which pushes prices up. A small amount of inflation is normal in a growing economy, but the Bank of England adjusts interest rates to ensure inflation remains low and stable in order to achieve price stability.

Interest rates control the price of borrowing and the value of saving—if they are low, borrowing is cheap and saving is not especially worthwhile, but when they are high, borrowing is expensive and saving more worthwhile. Adjusting interest rates therefore influences consumers’ spending habits, and controls the demand for goods and services—if demand far exceeds supply, interest rates can be raised to discourage spending and lower demand, whereas if supply exceeds demand (which could cause a general lowering of prices known as deflation), or demand is lower than usual (for example during a recession), interest rates can be lowered to encourage spending. In January 2009, to encourage spending to combat the recession brought on by the credit crunch, the Bank lowered interest rates to 1.5%—the lowest in the Bank’s 315-year history—then lowered them again in February, to 1%, and then again, in March, to 0.5%.

‘It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.’

HENRY FORD, US car tycoon

Данный текст является ознакомительным фрагментом.