how decrease ine the rate of interest would decrease the rate of inflation.

[Durrani Abid]

Today State Bank of Pakistan has decreased its interest rate from 10.5% to 10% and it says that decrease in the rate of interest would decrease the rate of inflation.

Can anybody explain that how decrease ine the rate of interest would decrease the rate of inflation.
Apparantly it shows that if the rate of interest decreases then people will not save in the banks and as the result too much money will be in the hands of consumers and too much money in the hands of consumer means rise in the inflation.

Many thanx

[sheroz]

inflation means increasing trend in prices. When interest rate is low people have a lot of money in their hands, this is due to two reasons, first people do not save their money in banks, secondly borrowing from banks also icreases. So when people have a lot of money at their disposal, they don,t care about prices, they just want their desires to be fulfilled, When this is the situation prices goes up and this trend of rising prices is called inflation. Inflation is caused by many reasons, low rate of interest is one of them.

[Durrani Abid]

Read my question

dear SBP claim that decrease in interest rate would decrease the rate of inflation. How that is my question how it claims

[ouneeb]

@durrani abid
well you will here a lot of answers but in my opinion it goes like this
SBP-----> give loans to other banks
other banks ------------> to public
let say sbp rate is 10%
other banks will charge 12 % from the public so money is not cheap
but if sbp rate is 8%
other banks will charge 10% from the public so comparatively it is cheap

Commercial banks need money to manage there cash flows and that they do by public borrowing and some part from SBP so if they get it cheap they will lend it cheap decreasing the inflation (rise in the price of the thing) because now Mr A (an industrialist) is getting loan at lower rates so he will sell his product to a cheaper rate.
may be that clear some things and google is your friend use it

[Durrani Abid]

Originally Posted by ouneeb

@durrani abid
well you will here a lot of answers but in my opinion it goes like this
SBP-----> give loans to other banks
other banks ------------> to public
let say sbp rate is 10%
other banks will charge 12 % from the public so money is not cheap
but if sbp rate is 8%
other banks will charge 10% from the public so comparatively it is cheap

Commercial banks need money to manage there cash flows and that they do by public borrowing and some part from SBP so if they get it cheap they will lend it cheap decreasing the inflation (rise in the price of the thing) because now Mr A (an industrialist) is getting loan at lower rates so he will sell his product to a cheaper rate.
may be that clear some things and google is your friend use it

look at from cost pull inflation rather than demand pull.
Interest is the price of money and money is the main factor of production and if its price decreases(interest rate) that will cause decrease in the price of commodity and hence decrease on the rate of inflation. :-)

[usman hameed]

dear investment is determined by interest rate, both have an inverse relationship,means higher rate of interest rate will decrease investment which in turn will decrease the output of the country and increase the prices as less production has taken place. similarly the lower interest rate has an opposite effect. it will increase investment and enhance the availability of goods which will be available at lower price. so decrease in interest rate decrease inflation. i hope you got an idea.

[shtanzeel]

in my opinion, the demand effect, due to cheaper loans, shall by multiplier effect, increase inflation manifold. However, if care is utilized to divert investments to productive sectors, instead of consumer items as done in 2000 era, it shall be less disasterous

[Descendant of Saul]

Considering all the above explanations, the statement that decreasing the interest rate would decrease the inflation, then the question that arises next is that:

"What is stopping the State Bank from significantly lowering the interest rate?"

What will happen if State Bank reduce the interest rates to suppose 5% as a supposed scenario? How is it going to impact the economy of Pakistan over all?

[Descendant of Saul]

In addition to my above question, while trying to find answer, i came across another post with contradictory statement. Can someone please clarify it!

Referring to this post:
http://www.cssforum.com.pk/499359-post1.html

It says:
"The most important and commonly used method to control inflation is monetary policy of the Central Bank. Most central banks use high interest rates as the traditional way to fight or prevent inflation."

With reference to the above, specifically the red/italic text, isn't it contradictory to what is being said and supported by all the people here?

Or is this statement that I have mentioned here is wrong?