Interest rates represent the cost of borrowing money or the return on saving it.

When interest rates are:

• Low → borrowing becomes cheaper, spending increases

• High → borrowing becomes more expensive, saving becomes more attractive

Central banks set key interest rates that influence the rates charged by commercial banks, affecting loans, mortgages, and savings accounts.

Quantitative easing (QE) is a monetary policy tool used when interest rates are already very low.

Under QE, a central bank:

• Buys government or corporate bonds

• Injects money into the financial system

• Lowers long-term interest rates

The goal is to stimulate economic activity and support financial markets during weak economic conditions.

Quantitative tightening (QT) is the opposite of quantitative easing.

Under QT, a central bank:

• Reduces its balance sheet

• Allows bonds to mature without reinvestment or actively sells them

• Removes liquidity from the financial system

QT is used to normalize monetary policy and control inflation after periods of high stimulus.

Inflation plays a central role in monetary policy decisions.

When inflation is:

• Too high → central banks tighten policy

• Too low → central banks ease policy

Central banks aim to keep inflation stable to protect purchasing power and maintain economic confidence.

When interest rates remain high for an extended period:

• Borrowing slows

• Investment declines

• Debt servicing costs rise

• Economic growth weakens

High rates can reduce inflation but may increase financial stress for households, businesses, and governments.

The monetary policy transmission mechanism describes how central bank decisions affect the real economy.

In simple terms:

1. Central banks change interest rates or liquidity

2. Banks adjust lending conditions

3. Businesses and households change spending and investment

4. Economic activity and inflation respond

This process takes time and varies depending on economic conditions.