Interest rates and inflation are intimately related
Central banks adjust monetary policies to manage inflation
Have you thought about why prices rise over time? Think about the price of a movie 20 years ago versus today—that’s the power of inflation. But inflation isn’t all bad. Mild inflation helps boost the economy because if consumers expect prices to rise they are more likely to spend today to avoid higher prices tomorrow. More spending in turn encourages economic activity, creates employment and spurs investment. Conversely, in times of deflation, when prices are falling, consumers typically defer spending and economic growth suffers.
Interest rates represent the cost of borrowing and are closely related to inflation. To stabilize inflation, central banks tend to adjust interest rates from time to time to ensure the economy will not get overheated or shrink. If interest rates rise, which means the cost of borrowing goes up, consumers will be more inclined to save than spend. Companies will also slow their investments because borrowing to expand is more expensive. The decrease in demand will end up holding back economic growth and slow down inflation.