Question

1) Which of the following is the most likely explanation of Japan's very low market interest rates in the early 2000s?

A) expected deflation

B) an increasing budget deficit

C) an increasing trade surplus

D) an increase in corporate profits

Answer: A

Why lower interest rate cause deflation in this question?

From Investopedia, 'In general, as interest rates are reduced, more people are able to borrow more money. The result is that consumers have more money to spend, causing the economy to grow and inflation to increase.' That makes me confused...

Answer 1

In General we will firstly discuss what is Inflation and deflation and then we will discuss how bank rate affect in both scenario.

Inflation

Inflation is the quantitative measure wherein the price of the products and goods increase over the time. it is the devaluation of the currency wherein money is easily available to which increase the demand of the products making them increase the price.

Deflation

Unlike inflation deflation is the situation wherein the prices level of the products decreases and money is not easily available to the end customer.

Demand and supply and affect of the bank interest rate on inflation and deflation

Demand and supply are the measure components affection inflation or deflation. As the demand of the products increases ultimately the price increases which is said to be inflation scenario and vice-versa if the demand decreases the price decreases as well.

So if the economy is is going through deflation phase than it generally means that the money is not easily available to the end customers which is impacting demand of the products and prices are going down. So to maintain the equilibrium of the purchasing price economy should maintain a balance inflation and deflation rate.

in the above scenario Japan was expecting deflation which means that demand for there product was decreasing which impacts directly on the price of the product too. Hence to increase the demand for the products the purchase of the product need to be increased for which money should be easily available to the end customers.

To make money easily available to the customers one can take Bank loan.

So if the bank rates are higher it can't pull the attention of the customers so the banks in Japan decided to lower the interest rate which can indirectly pull the attention of the customers which would help them get money easily and help increase the demand which would directly impact on the deflation rate and have it controlled.