How does raising interest rates slow inflation?

17 Jun. 2022

By raising rates, the Fed will discourage consumers from making large purchases and compels people to pull back on spending. The goal is to lower demand over time, allowing prices to come down and stabilize.

This power to set interest rates is one of the Fed’s main tools to steer the nation’s economy. The Fed can lower rates, making it cheaper to borrow, which encourages economic activity by spurring spending and investments. When the pandemic first plunged the global economy into a crisis, as businesses, government offices and schools closed, the Fed cut interest rates to near zero, a tactic many central banks had also used after the financial crisis in the mid-2000s. That made it less expensive for consumers to get a car or home loan and made other major purchases easier to come by.

But since climbing out of the covid recession, the economy faces new challenges. Inflation is at a 40-year high. Gas prices have surpassed $5 a gallon. And supply disruptions continue to plague businesses and consumers. So instead of cutting rates to encourage growth, the Fed is now trying to reverse course and cool the economy.


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