Question

What is the relationship between interest rates and demand for money

Answer 1

In general sense,the relationship between interest rate and money demand is inverse or negative.

Explanation:

• In Macroeconomics or Financial Economics,the relationship between money demand and interest rate is inverse or negative,indicating that as interest rate increases the demand for money decreases and vise versa.
• Now,as the interest rate rises,the cost of financial borrowing or loan also increases and hence,people would not want to borrow more money and save money as the future value of money would possibly increase due to higher interest rate.
• Therefore,an increase in interest rate is an example of contractionary monetary policy by the central bank which can reduce the current financial borrowing such as loans from the banks or other financial institutions thereby,decreasing for money in the economy as now people would have to pay higher cost or interest payments on their financial borrowings.
• In the same line of argument,a decrease in interest rate or an expansionary monetary policy by the central bank would lead to higher demand for money or financial borrowings such as bank loans as the cost of financial borrowing or the periodic interest payment on loans would decrease as a consequence.