Skip to content
Basic questions – money suppy and interest rates

This was originally posted in our forum and reposted here when the forum closed.

Q. I was wondering if I could have some help understanding some basics.

When a government increases the money supply, where does this money go immediately? I mean, when it increases money supply, who exactly gets this extra money, and how?

Also, I think that when there is more money, inflation rises. But how are interest rates affected? And why?

Finally, I know what deflation is, but I don’t understand what can cause it and the negative implications it has. Can someone explain it, in simple language please? I would be most grateful.

A. Usually the central bank hangs on to that money and slowly send it out as demand warrants. (That means the bigger banks borrow the money from the central bank.)

Inflation goes up dependent on consumer spending and behaviour, etc. Interest rates may increase in order to reduce spending. The central bank will make that decision to increase or decrease interest rates based on a bunch of data.

Deflation could theoretically occur (it does if you mean by deflation negative inflation). For example, the US finds a billion barrels of oil in Texas and prices decrease by 50%. That would lead to a drop in inflation.

Leave a comment

Your email address will not be published..