How does increasing interest rates affect inflation?

What are interest rates? Interest rates are the rate of return offered on any kind of loan or investment. In reference to monetary policy and manipulation, the interest rate refers to the rate set by the central bank. This is the rate of interest that the Bank offers to commercial banks on deposits. If the central bank increases their interest rate, commercial banks will tend to do the same.So how does increasing the rate of interest offered by commercial banks affect inflation?Multiple transmission mechanisms:Loans more expensive so firms take on less investment savings return more so consumers tend to put more money in the bank and dont spend itasset prices fall as a result of lower spending, affecting confidenceAll lead to lower Aggregate Demand (shift in), and we see on diagram how this results in lower price level

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Answered by Oscar B. Economics tutor

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