How can interest rates stimulate the economy ?

Additional Details
How can interest rates stimulate the economy ?

Also, is it true that "A low interest rate causes capital outflow"

Monetary policy
Central banks such as the U.S. Federal Reserve System can affect inflation to a significant extent through setting interest rates and through other operations (i.e., using monetary policy). High interest rates (and slow growth of the money supply) are the traditional ways that central banks fight inflation, using unemployment and the decline of production to prevent price increases.

However, Central Banks view the means of controlling the inflation differently. For instance, some follow a symmetrical inflation target while others only control inflation when it gets too high. The European Central Bank has come under some criticism for following the latter practice, especially in the face of high unemployment.

Monetarists emphasize increasing interest rates by reducing the money supply through monetary policy to fight inflation.
Keynesians emphasize reducing demand in general, often through fiscal policy, using increased taxation or reduced government spending to reduce demand. They also note the role of monetary policy, particularly for inflation in basic commodities from the work of Robert Solow.
Supply-side economists advocate fighting inflation by fixing the exchange rate between the currency and some stable reference currency such as gold, or by reducing marginal tax rates in a floating currency regime to encourage capital formation.
All of these policies are achieved in practice through a process of open market operations.

In economics, inflation is an increase in the money supply or an increase in prices.

The two most obvious versions of this, each held by some economists to be "real" inflation, are for prices of goods and services in the currency in question to rise, or for the money supply to increase.

Price inflation is closely akin to "cost of living" measurement, where a "basket" of goods is used as a standard and the prices of the goods are compared at two intervals and adjusting for changes in the intrinsic basket. But, technically, this is not raw inflation; it is an attempt to determine real-life value of money compared to the members of the society in question, adding other factors like increased expectations.

Raw inflation measurement does not adjust for expectations, but directly measures the change in the price of goods.

There are different measurements of price inflation, depending on the basket of goods selected. The most common measures are of consumer inflation, producer inflation and GDP deflators, or price indexes. The last measures inflation in the entire economy.

General price inflation is a fall in the purchasing power of money within an economy, as compared to currency devaluation which is the fall of the market value of a currency between economies. The extent to which these two phenomena are related is open to economic debate, though the comparison of a currency to foreign currencies is based on investor demand for currencies, and therefore must at least partially be a matter of perception.

Both of these are often caused by money being added to an economy, either as printed currency or as virtual money lent to banks or other entities. This is called currency inflation, and can cause price inflation or currency devaluation. But, because the general amount of wealth gradually changes in an economy (as long-lasting things are created, new technologies invented, et cetera), a small amount of currency inflation need not cause price inflation.

Some terms related to inflation:

deflation is a rise in the purchasing power of money, and a corresponding lowering of prices (the opposite of inflation).
Disinflation refers to slowing the rate of inflation, that is, prices are still rising, but at a slower rate than before.
Reflation is a term used to denote inflation after a period of deflation, meaning inflation designed to restore prices to a previous level.
Hyperinflation is rapid inflation without any tendency towards equilibrium - that is, an inflation that produces even more inflation.
In some contexts the word "inflation" is used to mean an increase in the money supply, which is seen as a cause of price increases. Some economists (of the Austrian school) still prefer this meaning of the term, rather than to mean the price increases themselves. Thus, for example, some observers refer to inflation in the 1920s in the United States even though the prices of some baskets of goods were not increasing at the time. Below, the word "inflation" will be used to refer to a general increase in prices unless otherwise specified.

The Central Bank of a country controls the quantum of currency flowing in the economy by increasing or decreasing the interest rates. Whenever there is an increase in the interest rate, people will tend to save. Thereby the circulation of money will reduce as a result of which the commodity prices will go down. Decreasing the interest rates would result in more circulation of money, more spending by the people and inflation.

Rising interest rates doesn't stimulate the economy at all, quite the contrary. Rising interest rates and the corresponding inflation hurts everybody. It's proof that our leadership is gleefully squandering billions making a very few on the buddy list scandalously rich and thousands dead, to steal oil.

Please folks, we don't need another war monger for president. We've tried that, been there, done that, it doesn't work and is horribly destructive and totally unfair to the weak countries we attack.

if the interest rates and dropped, then businesses who want to borrow money get it for cheaper, so theoratically they are willing to borrow more money.
with more money businesses can invest more there by producing more. hence economic growth.
also, people who want to buy, when interest rates fall, are willing to borrow more and buy large items like houses, cars, and even friges and other consumer products. more demand, stimualtes the economy.
why then would the interest rates ever be increased?? to stop inflation mainly - but that is another question

Lowering interest rates makes people less likely to save or invest, which in theory boosts spending, which stimulates the economy. However, this can also lead to inflation, which is the reason that interest rates are sometimes raised.

In general, the Federal Reserve is the bank for banks, and it controls the interest rate.
If the economy is rising too fast, meaning that people are buying a lot and businesses are producing many goods and services, the Fed may want to slow it down; to prevent a sort of "crash."
By raising the interest rate, the banks will have to raise their interes rates to compensate for the Fed's.
The rise in interest rates will cause people to slow down their spending, specially houses and cars. Credit cards will also raise their rates as well.

On the other hand, the opposite will occur if the people are not buying. The Fed will lower their interest to "stimulate" the economy. The banks will lower their interest rates and this will encourage people to buy homes and cars at a low interest level.

It's more complicated than this though.
But I hope this gives you a good idea.

low interest rates discourage saving, and encourage spendinga and investment in other things like businesses or stocks.
it also makes it easier for companies to borrow money to start up or expand.

It's a little bit more involved than what you might think, but the basis is true. Lower interest rates are supposed to kick-start the economy. The idea behind this theory is that by lowering rates, we are encouraging people and businesses to spend money on goods or services. When consumers increase their spending, many different things happen. I will use housing as an example because it is one of the key items that economists look at to gauge the health of the economy.

Let's say that for whatever reason, the Federal Reserve lowered the interest rate to 2.5%. Now, with this lower rate rate people start buying houses. Everytime a new home is built, there are people who are getting paid money as a result of that. The construction guys who build it, the retailers and suppliers who provide the materials, the manufacturers who make the materials, the people who delivery and package the materials, and even the people who process all of that paperwork. All of this extra work is provided for as the result of one house being built.

Now, once all of this happens all of these people who are involved now have extra money to spend. Whether it's spent buying products like cars or appliances, this extra income that comes as a result of having a job due to the need to build a house, is now puyt back into the economy to have the same effect in other business and industrial areas.

When these new houses get built, the people moving into them will also start purchasing new appliances and materials for this new house, which will in turn create more demand for products and cause companies to produce more. All of this happens when interest rates are low and people begin spending money and borrowing money.

This sounds great, and it is, but it also can be dangerous and bad. Using the same scenario, lets say that everyone is wanting to buy homes and build new homes. The demand increases and each company needs to hire more people so that they can build these houses. This creates new jobs, but the danger comes in when this demand happens too quickly.

Let's say you own ABC Construction, and you have orders to build 25 houses within the next two months. The most your current staff can build in that time is 20, so you know you're going to have to hire more people. Normally it's not a problem, but you're not alone in this. All of your competitors have done the same thing and they are looking for people to hire.

When there are more than one company looking for workers, the workers can and do demand a higher wage, which they will get. Now that the wages are increasing, this causes the companies to have to raise their prices to pay for these higher worker salaries. And as these prices are raised, other consumers are now feeling like they are getting less for their money and they begin to demand raises, which causes the companies they work for to increase their prices, which causes more workers to want better wages.

Eventually this will cause two things to happen. First is that consumers will stop buying as many of those products because of the higher cost or the company won't be able to make enough of them because they can't pay the higher wages for additional workers. When this happens, companies start laying people off. So now, there are less people working and making money and as a result they aren't buying as many things, which in turn leads other companies to take similar actions and they lay off people.

So, lowering interest rates is a SHORT term solution to fuel the economy, but those rates are raised when the Federal Reserve feels the economy is growing too quickly and it will try to "discourage" people from spending (and borrowing) by raising the interest rate.

Does that help?

lower intrest rates will give an incentuve to prospective borrowers to spend more money and buy more stuff/invest in capital investments. Rasie that rate and you will slow down the economy, which is desireable in times of inflation.

First of all, I'm no economist, but this is how I understand it and it makes sense:

Interest rates determine the 'cost' of money. Consider this from a consume who has credit cards. If the credit card interest rate is very low, then the consume would have an incentive to buy things, which stimulates the economy. If the interest rate is high (aren't they all), then the incentive to put off a purchase that can't be made with cash. (By the way, living with Cash is the way to go!)

There is a hugely important rate called the PRIME. This is the rate that the Federal Reserve (not a Government agency by the way) charges banks for money overnight. The banks then loan that money to its customers, like Mortgage companies. So when the PRIME is low, money for mortgages can be low, which makes houses more affordable. The rates have been very low lately and you've seen the housing boom. But when to many people start buying houses, then shortages start to appear. Shortages of concrete, wood, etc. This causes the prices of these commodoties to go up... which has a negative affect on inflation (prices go up).

So the Fed has been increasing the PRIME rate to make things cost a little bit more, which theoretically will slow things down just enough to prevent inflation.

It's a complicated mix of numbers really. I guess I'd put it this way.. when money is cheap, people buy things and the economy speeds up. When money is expensive, people hold off on buying and things slow down.

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