When inflation is high, central banks often raise interest rates. The goal is not to make everyday life more expensive; it is to slow demand enough to reduce pressure on prices.
Higher policy rates usually make mortgages, business loans and other borrowing more expensive. Saving may become more attractive. Households and companies may postpone some spending and investment.
When demand grows more slowly, businesses have less room to raise prices rapidly. Higher rates can also influence inflation expectations: if people believe the central bank will keep inflation under control, wage and price setting may become less aggressive.
The process is not immediate. Interest-rate changes take months, sometimes longer, to pass through the economy.
Central banks also face a difficult problem when inflation is driven by supply shocks. If war or disruption suddenly raises oil, gas or food prices, higher interest rates cannot produce more energy or wheat. They can, however, try to stop the initial shock from spreading into broader and persistent price increases.
There is a trade-off. Rates set too high for too long can weaken investment, housing and employment. Rates cut too early can allow inflation to remain elevated.
This is why central banks study incoming data on inflation, wages, employment, growth, credit and expectations before making decisions.
A common misunderstanding is that every fall in inflation means prices have fallen. Usually it means prices are still rising, but at a slower rate. Deflation is the separate condition in which the general price level actually declines.