First imagine this setting that results in inflation. The demand for
all products is up because people have a lot of money this year
(probably from a large increase in buying, resulting in higher income
for many whose income is linked to sales), but production was not
increased to prepare for this. Prices go up because more money is
thrown at sellers.
Increased interest rates help fix this by making money either harder
to get or less desirable to spend. Here are two simple examples.
If the interest rate for a car loan doubled, you would be paying more
per month to get the same car, and have less to spend on other things.
Or you would buy a cheaper car to have the same total cost. Either
way, you spend less on products.
At the same time, if the interest rate your bank paid you for your
savings account doubled (let's assume it isn't at almost nothing right
now), you might also be less inclined to spend money you have because
your bank is promising a decent profit if you don't.
In both cases, sellers would have to lower prices (opposite of
inflation) to get you to buy things. Note that in the US, the
government doesn't control savings account interest or mortgage rates
directly, but rather controls the interest rate banks must pay to
borrow money which they then loan to customers. The effect is still
the same. You could come up with similar examples involving credit
cards or various investments. |
