Why Rising Interest Rate Controls Inflation

One of the first responses to rising inflation is to raise interest rates therefore why do central banks raise interest rates.

Interest rate simply means the little extra money someone pays when borrowing money from the bank or or the extra income someone gets from living money in their account. Commercial banks set their interest rate but it's heavily influenced by the rates set by the Central bank. Commercial Banks normally have reserves that they deposit in the Central Bank and can earn interest from that reserve deposited.

Inflation simply means the continuous rise in the price of goods and services over time.

If inflation is too high banks raise interest rates which slow down inflation example A rise in interest rate by the Central bank means commercial bank earns more from their reserves meaning they make more from keeping their money with the central banks than lending it out therefore if they decide to lend it out they will increase their interest rate which discourages individuals from taking loan and also increases mortgage which as an effect leads to low disposable income.

Low disposable income translate to low business activities and discourages businesses from making additional investments either through loan or whatever mean. All this slows down Economic activity.

And causes demands for goods to be which means companies might start laying off staff and lowering wages. All this stop businesses from raising prices. Which stops inflation.

But the downside of this is that it can lead to recession.