Discount rate is the minimum interest rate set by the central bank of a country. It is used in controlling inflation. We all know inflation is an economic situation where the value of money falls and causes a rise in the general price level. Inflation occurs when there is excess money in circulation. This means that, much money will be used to purchase few goods.Â
The central bank uses discount rates to control inflation by taking out the excess money in circulation. They do this by increasing interest rates to encourage people to save or invest and discourage borrowings. By saving and investment, the excess money in the economy is taken out. For instance, if interest rates are set at 20%, people would prefer to save or invest their monies so as to get a high return on investment rather than borrowing from the banks and pay high interest rates. Â