A government’s central bank raises interest rates when inflation is high as a way to slow down economic activity and reduce inflationary pressures. When interest rates increase, borrowing money becomes more expensive for consumers and businesses, leading to reduced spending and investment. This decrease in demand for goods and services helps to lower prices or at least slow down price increases, ultimately cooling inflation. Higher interest rates also encourage saving rather than spending since savings offer better returns with the increased rates. As spending drops and saving rises, overall demand in the economy lessens, which tends to bring inflation down closer to target levels—many central banks aim for around 2% inflation. In summary, raising interest rates helps control inflation by:

• Making loans and credit more expensive, thus reducing consumption and investment.
• Encouraging savings instead of spending.
• Lowering overall demand for goods and services, leading to slower price growth or falling prices.

Central banks use this tool to maintain price stability, protecting the economy from the damaging effects of excessive inflation, such as eroding purchasing power and economic uncertainty.