If the central bank increases the bank rate, the lending rate by the commercial bank would increase, this would increase the cost of loans. To cope up with it, producers would rise the price of their goods. Thus inflation would rise, but in study material it is mentioned that increase in bank rate reduces inflation how it is possible?

Dear Student

If interest rates in banks increases people start taking less loans because they will have to pay higher interests . Also people start saving more . As interest is the benefit people get from saving in banks . So in order to get more interests saving tendency rises . So we find that liquid money in the hands of people and consumption tendency decreases . This leads to a stagnation and fall of aggregate demand in the economy . So prices of goods start to fall and hence inflation is reduced .

Regards .