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How Interest Rates Are Affected by Inflation


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Inflation results in the decrease of the value of the dollar. That means that in the financing market, borrowers are more inclined to borrow money, but lenders are less inclined to make loans. A lender knows that the money he is paid back over time will be of less value than what he loans. To make up for their loss, lenders raise interest rates.

Higher interest rates means higher prices and people find themselves needing to borrow money to accomplish things they need to do, like improvements on their home or purchasing a car. Just like with anything, the higher demand for an item the higher the price is. So a high demand for money means the price of it, or the interest rate, will go up.

Individuals have little or no control over inflation. It is caused by the government, its borrowing habits or use of funds. It is also affected by how much currency or credit the government issues. Being knowledgeable about the causes and advocating sound policies is the only recourse people have.

Fortunately governments are not increasing inflation at a steady rate so they are not constantly on the rise. If they were interest rates would reach an unimaginable rate as they did back in the 70's. So borrowers need to keep an eye on the situation and act accordingly.

The government controls inflation by turning the tables on things to slow things down in the lending market. The lender and borrower in affect trade places as to their vantage point.

Deflation has as much affect on everyone as inflation. It means lower interest rates. So borrowing money is more appealing. But now the money you borrow will be of less value than it will be in the future. Your loss is that as you are paying on the loan the money you are giving up would be worth more if you could save or invest it.

So the key is the try to determine which way things are going to go ñ inflation or deflation. Many professional have hard time making such predictions. So how can the average person know what to expect?

There really is no method of calculation. But there are some things that give a good indication. In times past the dollar was related to hard commodity, gold and silver. So you could se these commodities as an indicator. That is no longer the case. But there are still some indicators out there that can give you some direction.

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