Inflation vs Interest Rates

Inflation vs Interest Rates

Inflation vs Interest Rates

Relation between Inflation and Bank interest Rates

Inflation vs Interest Rates

Now a days, you might have heard lot of these terms and usage on inflation and the bank interest rates. We are trying to make it simple for you to understand the relation between inflation and bank interest rates in India. (What is Deflation?)

Bank interest rate depends on many other factors, out of that the major one is inflation. Whenever you see an increase on inflation, there will be an increase of interest rate also.

What is Inflation?

Inflation is defined as an increase in the price of bunch of Goods and services that projects the Indian economy. An increase in inflation figures occurs when there is an increase in the average level of prices in Goods and services. Inflation happens when there are less Goods and more buyers, this will result in increase in the price of Goods, since there is more demand and less supply of the goods.

Inflation causes increase of Interest

Inflation can be recognized as a combination of 4 factors :

  • The Supply of money goes up
  • The Supply of Goods goes down
  • Demand for money goes down
  • Demand for goods goes up

Our Indian government gets involved in it to control the inflation by adjusting the level of money in our economical system. The most noticeable way to increase the money flow in the system is to print more currency, then the rupees will become more relative to goods.

Inflation and Global Liquidity

Factors like rates of import and export, the production cost of farms, value of dollar, price of oil (crude oil), market movements of other overseas markets cause global liquidity. In India, we can also feel the effects of global liquidity. We are not isolated from all these issues now. Due to the remarkable economic growth of India over the recent years, increase in foreign currency inflow caused the demand in multiples for many Merchandise and services in India. RBI (Reserve Bank of India) needs to control this excess liquidity in our economic system. For this, RBI increases the Repo rates which makes Costly Credits and thus increases the CRR rate (Cash Reserve Ratio). This kind of measures by RBI can only control the inflation to a certain extent only.


Due to Globalisation, no country are independent from Global Liquidities. This causes an important factor for the inflation in a country. A political crunch or economical downturn in a far away country can impact our money value in India

What is a CRR rate?

Cash reserve Ratio (CRR) is the amount of funds that the banks have to keep with RBI. If RBI decides to increase the percent of this, the available amount with the banks comes down. RBI is using this method (increase of CRR rate), to drain out the excessive money from the banks.

What is a Bank Rate?

Bank rate is the rate at which RBI gives to the commercial banks. Whenever RBI increases its rates, the effect will be shown on the commercial banks. In this case, the commercial banks have to increase the interest rates for their profits.

What is a Repo Rate?

Whenever the banks have any shortage of funds they can borrow it from RBI. Repo rate is the rate at which our banks borrow rupees from RBI. A reduction in the repo rate will help banks to get money at a cheaper rate. When the repo rate increases borrowing from RBI becomes more expensive.

What is a Reverse Repo Rate?

Reverse Repo rate is the rate at which Reserve Bank of India (RBI) borrows money from banks. Banks are always happy to lend money to RBI since their money are in safe hands with a good interest. An increase in Reverse repo rate can cause the banks to transfer more funds to RBI due to this attractive interest rates. It can cause the money to be drawn out of the banking system.

Due to this fine tuning of RBI using its tools of CRR, Bank Rate, Repo Rate and Reverse Repo rate our banks adjust their lending or investment rates for common man.

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  1. A good article which explains about the relation between inflation and interest rates. Inflation increases the prices of all the goods in a country, be it FMCGs, shares, loan interest rates etc. Inflation and interest rates are directly related to each other. If there is an inflation, there will be a cash crunch (shortage of cash) with the banks as well as consumers. With proper alterations in the CRR, Repo rate, Reverse Repo rate and Bank rate, RBI puts a control on the inflationary situation.

  2. Whenever I think of inflation, I just think of those old pictures of people carting wheelbarrows of money down. Remember when inflation was so bad in Germany (just after world war 1) that this happened? I’m sure it’s happened many other countries too.
    I’m so glad there are checks and balances to prevent this happening again… so banks can control inflation and we won’t end up with wheelbarrows full of worthless cash that can barely buy a loaf of bread. Though I’d really like a wheelbarrow of cash where there is not too much inflation around 🙂 🙂 hahahaha

  3. Inflation has become a common term today. It is the increase in demand of any goods and services and less supply. This is usually affected by increase in petrol or diesel price in our country. Whenever there is an increase in price of petrol there is a splurge in price of the various commodities. The reason cited is usually global.