Quote:
Originally Posted by waqas izhar
this is not how it works the way you mentioned it.
a higher interest rate leads to savings in the bank. then the bank gives away those savings as loans. those loans are then invested or consumed. the downside is that if you are getting an interest rate of 10 for your savings you won't invest it if the profits from investment is 7, 8 or 9. similarly if the profit is 9 and the bank is giving away loan at 11 then the investor won't take the loan. the money will stay in the bank and not become part of the investment.
regards
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If the interest rate is zero then every project seems feasible. Many gullible investors will rush to start things and in the process will not care much for efficiency. The result will be bulk of investment in those projects Which are not offering the best returns. Capital that can be used on better projects would be lost. Chances are that many incapable people will get loans from the banks because there is no tension of paying interest and not only they will not make any profits they will waste the original sum also.
Also increase in investment causes inflation because investment trickles down to labor force via wages and this higher income leads to higher demand for goods and thus the inflation.
"The current president of American federal reserve called for a tight monetary policy to check the Inflation wave in the country. She/he said that in previous years interest was lowered to encourage investment and employment but the time has come to increase interest."(I read her/his interview a year ago perhaps).
You can also read about Philips curve to know the link between investment and inflation.
http://en.wikipedia.org/wiki/Phillips_curve