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India has just dropped its lending rates. Is the drop in interest rates linked to the country's inflation?

Link to article - http://in.reuters.com/article/2015/09/14/india-economy-inflation-idINKCN0RE04V20150914

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  • $\begingroup$ Economics again. $\endgroup$ – Ross Sep 30 '15 at 19:56
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    $\begingroup$ Usually interest rates are dropped because growth and inflation are slowing down compared to the normal or targeted growth levels for that country. $\endgroup$ – Victor Sep 30 '15 at 21:14
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You're probably not looking for a complex scientifical discussion on the subject, so here's a very simplified description of the mechanism:

Lower interest rate => Loaning money is cheaper => More money in the system => Higher inflation.

So the change in inflation is one of the products of government/central bank changing interest rates.

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As John L said "Lower interest rate => Loaning money is cheaper" - agreed. The next link: "Loaning money is cheaper => More money in the system" is rather more subtle. It assumes that you know about fractional reserve banking and that bank loans create money. You should also be aware that bank loan repayments (of principal) destroys money. So the money supply will only rise upon lower interest rates if the rate of making new loans is greater than the rate at which existing loans are paid back. It just so happens that central banks are likely to lower interest rates at exactly those times when the enthusiasm for taking out new loans is falling. So the relationship between interest rates and inflation can end up being quite complex.

And another factor is that not all stuff that money buys in the economy is stuff that is measured by inflation statistics. For example shares and houses. If the proportion of money being spent on those things (as a fraction of total spending) rises or falls then this too can cause inflation/deflation.

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