Why do central banks typically raise interest rates?

• A. To lower the money supply by reducing lending and spending
• B. To weaken the currency to boost exports
• C. To stimulate the economy by making borrowing cheaper
• D. To curb inflation by reducing borrowing and spending

Answer: (D)

Raising interest rates is a way to cool inflation by dampening demand. When policy rates rise, borrowing becomes more expensive—mortgages, car loans, credit cards, and business loans all cost more. That encourages households to delay big purchases and firms to pull back on investment, so overall spending and economic activity slow. With less demand pressure, price increases ease, helping to bring inflation back toward the target. Higher rates can also attract capital, which can strengthen the currency and further reduce inflation from imports. This approach is contractionary by design, balancing growth against price stability. It’s not about stimulating the economy or directly shrinking the money supply; the goal is to reduce borrowing and spending to curb inflation.