> Can someone explain to me how raising interest rates combats inflation?
ELI5:
Inflation is directly proportional to the money supply. The more money is circulating, the more things cost.
Money supply is inversely proportional to interest rates. If I could borrow at 0% APR, I will happily borrow a trillion dollars, even if I had no idea what to do with it.
And now the important thing: In modern economies, when people borrow money, that money is magically created out of thin air and added to the money supply.
This means that when interest rates drop, money supply goes up, and inflation goes up.
When interest rates rise, money supply goes down, and inflation goes down.
There's a lag to these effects, and there's a limit to how much interest rates can affect inflation, and there are other factors at play, but this is the bare bones of it.
ELI5:
Inflation is directly proportional to the money supply. The more money is circulating, the more things cost.
Money supply is inversely proportional to interest rates. If I could borrow at 0% APR, I will happily borrow a trillion dollars, even if I had no idea what to do with it.
And now the important thing: In modern economies, when people borrow money, that money is magically created out of thin air and added to the money supply.
This means that when interest rates drop, money supply goes up, and inflation goes up.
When interest rates rise, money supply goes down, and inflation goes down.
There's a lag to these effects, and there's a limit to how much interest rates can affect inflation, and there are other factors at play, but this is the bare bones of it.