During Inflation, interest rate will

1. Analyze the question The question asks what happens to the interest rate during inflation, which is a sustained rise in the general price level.

2. Explain the concept

• Inflation reduces the purchasing power of money. A naira repaid later buys less than a naira lent today.
• Lenders therefore demand higher nominal interest rates to protect the real value of their returns. This is the Fisher effect: nominal interest rate ≈ real interest rate + expected inflation rate.
• Central banks, such as the CBN, usually raise the Monetary Policy Rate (MPR) to fight inflation. This raises borrowing costs, reduces spending and cuts the money supply.
• Higher demand for loans, because people borrow to buy before prices rise further, also pushes interest rates up.

3. Step-by-step solution

• Inflation occurs, so prices rise and money loses value.
• Lenders want compensation and the central bank tightens policy, so interest rates rise.
• Option B (fluctuate) is too vague. Option C (constant) ignores the Fisher effect. Option D (fall) describes what happens in deflation or recession, when central banks cut rates to stimulate spending.

4. Answer Interest rates rise during inflation.

5. Exam tip Remember: "Inflation up, interest up." Lenders and central banks raise interest rates to protect money's value and cool spending. Interest rates fall when the economy needs stimulating, as in a recession.