Short Answer 
Understanding interest rates is crucial as they affect borrowing costs and overall spending in the economy. Governments control inflation by reducing spending and increasing taxes, while raising interest rates leads to decreased borrowing and spending, ultimately helping to lower inflation and stabilize prices.
Step 1: Understand Interest Rates
Interest rates are the cost of borrowing money, expressed as a percentage of the loan amount. When these rates increase, it becomes more expensive for individuals and businesses to take out loans. As a result, people and companies tend to borrow less, which leads to a decrease in overall spending in the economy.
Step 2: Government Actions to Control Inflation
To control inflation, governments may implement specific policies such as:
- Reducing government spending
- Increasing taxes
These measures aim to lower the amount of money circulating in the economy, which is essential for managing rising prices and ensuring that inflation does not escalate.
Step 3: The Relationship Between Interest Rates and Inflation
By raising interest rates, the government effectively reduces overall spending in the economy. This interaction can lead to two key economic outcomes:
- Higher Interest Rates: Result in decreased borrowing and spending.
- Lower Inflation: Less spending helps to ease inflationary pressures.
Ultimately, this policy can help stabilize prices and improve economic conditions over time.