Interest rates: inflationary/deflationary

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    Most economists view low interest rates as inflationary. Few argue that low interest rates are deflationary. Hazlitt says that you are not going to see the general price level rise, except by way of money and credit expansion

    This is a difficult topic. I see merit in each argument.


    Low interest rates drive credit expansion.
    High interest rates make the cost of everything more expensive

    What is a better way to explain this so that I know who is right?


    We have a monetary system with a central bank, which produces fiat money, and fractional-reserve commercial banks, which produce money substitutes only fractionally-backed by a reserve of money. In such a system, the central bank engineers monetary inflation through credit expansion. The central bank buys assets from commercial banks and pays them with reserves. With greater reserves, banks can issue more money substitutes, i.e., checking account balances, to their customers by extending them loans. The additional money that is created in this process tends to generate price inflation while the additional credit created tends to push interest rates down.

    In short, monetary inflation is the cause of price inflation and credit creation is the cause of low interest rates.

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