Question

(CO 4) Explain how price expectations influence the level of interest rates. What impact has inflation premiums had on interest rate levels in recent years?

Answer 1

Price expectation will be having influence on the level of interest rates because price expectation are reflection of the demand which is visible in an economy and when there would be a high level of demand, it will mean that there would be a high level of inflation as well and it will also mean that the monetary flow will be also higher so monetary policy is always trying to control the money flow into the system and when there would be a higher level of price expectation that will mean there will be a higher level of inflation into the economy and Central banks will be trying to increase the interest rate as it is one of the tool of the monetary policies and when there would be an increase in interest rate and money flow into the economy can be controlled to a significant level and interest rates are raised to control inflation in the economy.

Price expectation influence on the level of interest rates on the downside is also impactful as when there would be a lower level of interest rate, it will mean that Central banks has pushed the interest rate in order to stimulate the demand into the economy because the demand has fallen to a significant level and inflation has also fallen to a significant level so Central banks are trying to generate the demand into the economy in order to increase the prices and it will also mean that it will increase the money flow into the economy.

When there would be a higher amount of inflation premium, it would mean that there is a significant inflation rate into the economy and interest rates are also higher in the scenarios where the interest premiums are existent, and it will mean that interest rate has been pushed up in order to control the premiums of the inflation because inflation is reflecting the higher level of monetary flow into the economy and expectation of a price boom which would be controlled by higher level of interest rates and interest rate would be significantly reduced if there is is a low level of inflation in the entire economy.