The federal reserve lends money to banks. Banks can, and do, borrow massive amounts of capital from the Fed, which they use to lend money to everyone else. Generally speaking, bank-to-everyone-else loans have a higher interest rate than fed-to-bank loans (since otherwise the bank is losing money acting as a middle-man).

By raising their interest rate, the fed makes borrowing from them more expensive. That reduces the amount banks borrow from them to re-loan to others, which in turn reduces the money supply - the availability of money as opposed to other goods - in the economy as a whole. Since high money supply is one cause of inflation, this can help reduce inflation through government policy. (The current episode of inflation is pretty weird though, and only loosely caused by money-supply issues.)

It means that the Federal Reserve is setting the target for how much interest they charge when they lend money to banks. In turn, this raises how much banks charge each other for overnight loans. By setting the rate higher, banks will be less likely to borrow money and more likely to hold what they have. Essentially, banks are less likely to borrow and lend money, which means there is less money to go around

It also increases the interest rates for consumer loans. This means that people will be less likely to make larger purchases that require financing, and will be more likely to save money to take advantage of the higher returns.

Since there is less spending going on and less money to go around, demand for products goes down, which should force retailers to reduce their prices (or lessen the amount they increase them by)

Inflation is caused by money becoming worth less due to more of it being available.

One of the main ways people get access to more money, is by borrowing for institutions like banks. If the bank is loaning out money for 0% interest rates, this will stimulate the economy to grow, as people are borrowing and spending more money.

However, borrowing money for 0% interest would mean that there is little incentive for people to think to much about what they are borrowing, so too much money is released into the economy, decreasing the value of money overall. If everyone has 100$, really nobody as 100$. This causes the bubbles you’ll hear everyone talking about, and is why companies like Tesla are overvalued. People can invest tons of money into them for little interest.

So when the Fed increases interest rates, people will start borrowing less, as the monthly payments will make them think a lot longer about what they want to invest into. So higher interest rates means less borrowing, means less money being freely available in the economy, meaning the strength that 1 money is more, decreasing inflation.

TLDR: more borrowing due to lower inflation, the less money is worth(inflation). Less borrowing due to higher inflation, the more money is worth(deflation).

Sorry if this is a bit all over the place, hope it kinda helps

The Federal Reserve (AKA: the Fed) loans money to banks in order to keep the flow of money between borrowers, lenders, and savers.

In order to control how much money is entering the economy this way, they raise or lower the interest they charge banks to borrow from them.

By lowering the Fed's interest rates, it makes it easier for banks borrowing money to offer low-interest loans to borrowers (like car and house loans), but also makes the banks less likely to offer high-interest savings accounts to savers, since they can get the money cheaper and reliably from the Fed.

By raising the interest rates, Banks will A) need to raise interest rates on the loans they offer in order to still make a profit and thus remain in business, and B) raise the interest rates on savings accounts so that more people deposit their money with the bank, which is necessary in order to have the money on-hand to offer the loans while borrowing from the Fed is more expensive.

In turn, this results in affecting how much money people have available for purchases. When people have more cash to spend, this increases demand, driving prices up (inflation). When people have less cash on hand, or would rather hold their cash in savings accounts in order to collect more interest, demand decreases, resulting in a downward pressure on prices (ideally only slowing inflation to a manageable level rather than entering deflation, which has its own disruptive effects on the economy).

When they raise the rate, it costs more to borrow. Since it costs more, banks don’t borrow as much. When banks don’t borrow as much, less money is in circulation. Less money in circulation reduces spending, which will slow down inflation.

Why is the current episode "weird"?

Didn't the government "print" lots of money for covid benefits? Isn't this round of inflation linked to that?

Money supply and money demand(which is loosely what prices are.) are linked but not a perfect ratio, such that a 10% increase in supply won't perfectly follow with a 10% increase in demand.
Current inflation being "weird" is because there are many simultaneous causes here. Covid money isn't the only or primary one.

> Didn't the government "print" lots of money for covid benefits?

The current episode of inflation started well after those policies had mostly ended.

Remember, "inflation" is just a term for "a general rise in prices". And there are obvious reasons for such a rise:

• Supply chains were badly disrupted during covid, and remained so into 2022 in part due to China's aggressive zero-covid policies. And since supply chains have many steps, it takes a long time for those effects to work their way through the system: a shortage of metal today might mean a shortage of lumber tomorrow if the lumber supply depends on, say, being able to buy more chainsaw blades.

• Wages have risen [though not as fast as inflation] due to a hot labor market, which in turn is due to a combination of retiring Boomers, a non-trivial chunk of the population being killed or crippled by covid, and a culmination of existing trends in labor movements.

• Rising wages did create some increase in the money supply.

• Energy costs are pretty high. This was especially true in the immediate aftermath of the Russian invasion of Ukraine, which caused a big disruption to energy markets.

• All of this created an environment where profiteering was easy and could be blamed on "inflation" without brand damage. Fortune 500 companies posted record profits in that environment by considerable margins, even in real (inflation-adjusted) terms. A quick look at their list shows us that 200 of the Fortune 500 had their profits double or more in 2022, and many more posted growth far far above inflation.

I am not enough of an economist to tell you which of these is most important (and given the general voodoo that is economics I'm not sure I'd trust actual economists to say with that much confidence either), but at the very least there's plenty of alternatives to covid-related money supply.

Thank you so very much for using your time to give such a detailed answer. Much appreciated!

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