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What is the relationship between inflation and interest rates?

Practice Questions

Q1
What is the relationship between inflation and interest rates?
  1. Higher inflation typically leads to lower interest rates
  2. Higher inflation typically leads to higher interest rates
  3. Inflation has no effect on interest rates
  4. Interest rates are always fixed regardless of inflation

Questions & Step-by-Step Solutions

What is the relationship between inflation and interest rates?
  • Step 1: Understand what inflation is. Inflation means that prices of goods and services are increasing over time.
  • Step 2: Know what interest rates are. Interest rates are the cost of borrowing money or the return on savings.
  • Step 3: Recognize that when inflation is high, the value of money decreases. This means that money will buy less in the future.
  • Step 4: Realize that lenders want to protect themselves from losing money due to inflation. They do this by charging higher interest rates.
  • Step 5: Conclude that when inflation goes up, interest rates usually go up too, so lenders can maintain their purchasing power.
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