how do interest rates and inflation interact with each other in an open economy? What does a change in either mean for the other?
In: Economics
Answer: You can think of inflation as the value of money dropping in relation to the value of *stuff*. One year, a brick costs ten cents, the next year it costs eleven cents, the next year twelve, and so on.
Now, when someone loans money, they charge interest in order to make more money than they gave out- they give you today’s money, and you pay them back with future money. How much inflation is going on determines how much less future money is worth compared to today’s money. If inflation is higher, or is expected to be higher, then interest rates will also go up because the lender will need *even more* future money to get the return they wanted in terms of actual buying power.
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