why does the Reserve bank, in order to get inflation under control, raise interest rates, which raises cost of living? it seems like it would make the situation worse (at least in the short term)

30 views

why does the Reserve bank, in order to get inflation under control, raise interest rates, which raises cost of living? it seems like it would make the situation worse (at least in the short term)

In: 9

When interests rates rise more money ends up in banks. This results in people spending less money. With people spending less money the demand for goods goes down. With the demand for goods going down inflation should also decrease as companies will respond to lower demand by decreasing prices.

Higher interest rates make borrowing money more expensive. When money is expensive to borrow, folks are less inclined to do so. When less people borrow money, the money supply contracts. When the money supply contracts, folks have less money. When folks have less money, they buy less. When folks buy less, demand is reduced. When demand is reduced and supply is not, then prices either go down or stop rising.