Research Paper: First Draft

Thesis Statement

There is an inverse relationship between interest rates and inflation; Low-interest rates increase money circulation, leading to economic growth that fuels an increase in inflation.

Supporting evidence 1

The quantity theory of money poses that money supply and demand determine the inflation rate in a country. If there is a high supply of money, the price of goods goes up because the money becomes less valuable (Brei et al., 2020). On the contrary, when the supply of money is low, goods and services go down, reducing inflation.

Supporting evidence 2

Interest rates also affect inflation because interest rates determine the price of loaning money. When the interest charged on loans is low, many people demand more loans, increasing the supply of money in the economy (Hasanudin, 2021). As the money supply increases, the prices of goods go up, leading to inflation. On the other hand, higher interests prevent people from taking loans. Money supply becomes scarce, leading to reduced prices of goods and services, which reduces inflation.

Supporting evidence 3

Interest rates affect businesses' and consumers' psychology too, which shapes their spending. High-interest rates push consumers and businesses to cut down on spending. Reduced spending reduces the overall demand for goods and services in the market (Haksar & Kopp, 2020). Suppliers respond to reduced demand by lowering prices so that they can be affordable to the target market. In turn, this reduces the rate of inflation.

Supporting evidence 4

High-interest rates increase the cost of bonds, and the demand for lower-yield bonds reduces. When the demand goes down, the government will be forced to reduce the prices to attract potential bond buyers (Marx et al., 2021). When the interest rates are lower, the prices for bonds also decrease, attracting more people. This increases the supply of money, which leads to increased prices.

Conclusion

Interest rates shape the economy by affecting bond interest, loan interests, and consumer/business spending habits. A high-interest rate reduces consumer spending, business spending, and demand for loans, increasing the supply of money (Angelina & Nugraha, 2020). Consequently, the prices of goods go down, which implies reduced inflation. On the contrary, when the interest rates are low, consumer and business sending is high, demand for loans also go up, leading to increased supply of money in the economy, attracting inflation. Therefore, there is an inverse relationship between interest rates and inflation.

References

Angelina, S., & Nugraha, N. M. (2020). Effects of Monetary Policy on Inflation and National Economy Based on Analysis of Bank Indonesia Annual Report. Technium Soc. Sci. J., 10, 423.

Brei, M., Borio, C., & Gambacorta, L. (2020). Bank intermediation activity in a low‐interest‐rate environment. Economic Notes, 49(2), e12164.

Haksar, V., & Kopp, E. (2020). Back to Basics: How Can Interest Rates Be Negative?. Finance & Development, 57(001).

Hasanudin, H. (2021). The Effect of Inflation, Exchange, SBI Interest Rate and Dow Jones Index on JCI on IDX 2013–2018. Budapest International Research and Critics Institute (BIRCI-Journal): Humanities and Social Sciences, 4(2), 2063-2072.

Marx, M., Mojon, B., & Velde, F. R. (2021). Why have interest rates fallen far below the return on capital?. Journal of Monetary Economics.

RT Ferreira, T., & Shousha, S. (2021). Supply of Sovereign Safe Assets and Global Interest Rates. International Finance Discussion Paper, (1315).