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High interest rates slow inflation...but how?

Posted at 5:21 PM, Jun 15, 2022
and last updated 2022-06-15 19:21:02-04

Few people really understand all the complexities of the Federal Reserve Bank, which is this reporter’s way of saying I don’t understand it all myself.

The impact of the Fed’s interest rate changes on inflation is easier to understand. Just remember that any simple explanation leaves out the crucial fact that outside events and the endless variables called individual human choices can upend the elegance of simple explanations.

Here's the idea:

Your bank has a lot of money, but they don’t have it in a box in the corner. It’s invested in everything from Stocks and Bonds to the loans it’s already given.

Your bank needs a bank. That’s the Federal Reserve for the most part.

When you need a loan, the bank may decide you are a good investment. If they don’t have enough cash on hand for all the good loan seekers, they can go to the Fed to get cash.

If they get approved, the money from the Fed is lent at the rates set by the Federal Open Market Committee, which combines the expertise of the various branches of the Fed to make big decisions.

The news today (Wednesday) of a .75% increase in the Fed’s rate means banks will pay that much more for money.

When the banks pay more, they increase interest on the loans they grant.

When loans cost more, there’s less money circulating. Less money means less demand for goods and services.

Less demand slows inflation.

Sometimes, though not always, rising interest rates lead to recession.