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The classical theories of interest rate policy, inflation and economic growth

Definitions

Inflation

* Inflation is the increase in the overall level of prices (Principles of Macroeconomics –Mankiw). In an economy, we can see two contrast definition deflation and hyperinflation. Deflation is the decreasing average price (occurred in the US in 19th century). On the contrary, Hyperinflation is an extraordinary high rate of inflation (usually 50% per month). With that level of inflation, after one year the price of goods and services increases about 130 times. An example can be easily seen in Germany experienced in the 1920s.

Interest rate

Rediscount rate

* The discount rate is the interest rate charged to commercial banks and other depository institutions on loans they receive from their State Bank's lending facility - the discount window. It is the rate applied on the basis that the objective is valuable papers such as bonds, bills of exchange,... Commercial banks is willing to pay the owner of papers to exchange a profitable sum, which is called “discount rate” and receive that money from the owner at the time of due. In the case that these banks are in need of money but those papers are not due, banks re-sell those papers to State Bank to receive cash money and discount a sum to State Bank. This sum of money is called rediscount rate.

* Under the primary credit program, loans are extended for a very short term (usually overnight) to depository institutions in generally sound financial condition. The lower the discount rate, the cheaper are borrowed reserves, and the more banks borrow at the State Bank’s discount window. Hence, a reduction in the discount rate raises the monetary base and the money supply.

Refinancing rate

The Refinancing Rate is defined as the rate of interest imposed by the State Bank of Vietnam on loans to its member banks when the institution exceeds its credit limit.

This rate is used by the State bank to depository...