Controlling inflation is crucial for the health of the economy because if there’s too much money in circulation, prices get pushed up as consumers compete to buy goods and services. As the price of one thing goes up, other things that are dependent on it also go up in price, so, if the price of flour goes up, then the price of bread, made from flour, is also likely to go up. Of course, the whole process of inflation is much more complicated than this, but this is a good example.
The government can help control upward pressure on prices by raising interest rates. This makes it harder for individuals and businesses to borrow money and more expensive for them when they do so. This takes money out of the economic system, which then reduces economic activity; therefore, helping to keep prices down.
On the other hand, if the economy is in a slump, the RBA can make money ‘cheaper’ by lowering interest rates, which they hope will then encourage people to go out and spend more, thus stimulating the economy.
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