Readers Question: Does low inflation always mean low interest rates?
Yes, Generally low inflation will lead to low interest rates.
The UK has an inflation target of CPI = 2%. Therefore, interest rates are used to achieve this target. If inflation falls to below 2% the MPC will cut rates to maintain economic growth. There is no need for high interest rates when inflationary pressures are low.
For example: If you had an inflation rate of 1% and interest rates of 7%. There is a very high real interest rates (7-1 = 6%) Therefore, this would encourage saving and discourage borrowing and spending. This is likely to cause a recession so Central Banks would avoid it.
Will the Monetary Authorities ever Increase Interest Rates when Inflation is Low?
They might increase interest rates a little if:
- They forecast inflationary pressures will increase in the future
- They want to increase the value of the exchange rate
- They want to encourage saving as opposed to inflation.
However, as a general rule, Central Banks would rarely have interest rates more than 3 % points above the inflation rates. e.g. if inflation is 2%, it is unlikely that interest rates will be much more than 5%
4 comments ↓
IS LOW INFLATION AND DEFLATION THE SAME???
Deflation is when inflation rate becomes negative or is below 0.
Low inflation or disinflation is the rate of inflation growing at a slower pace
If inflation is negative i.e. deflatiion then why the rates of every thing is increasing??
if its so bad lets boycot every thing then. but thats just me im all about anarky.
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