Interest rates indicate how much it costs to borrow money and how much savings and investments make. For example, if I deposit $ 100 in a bank and the annual interest rate offered by the bank is 1%, after a year my $ 100 will have become 101. Thus the benefit of depositing my $ 100 in a bank will be 1 dollar, also meaning my deposit will return me 1%.
In general, when a central bank says it will raise interest rates, which is happening these days, it is referring to the rates at which central banks lend money to other banks. Then clearly these interbank rates will be reflected in the relationships that individual banks have with their customers. For the logic highlighted above, central banks use interest rates as a tool to incentivize or discourage the economic activity of citizens.
When an economy is in recession, it is useful to have zero interest rates because we want citizens and entrepreneurs to feel encouraged to spend the money they have in the bank, take out loans and perhaps take risks on investments that could stimulate the economy. On the contrary, when the economy is very active and there is a risk of speculative bubbles, it is useful to have positive interest rates that discourage risk-taking and deflate the bubble.
In other words, if the interest rates are zero, I will be more inclined to apply for loans and take economic risks such as investing in a mortgage or requesting a loan to open a business, since the cost of the money I am going to request will be zero. If interest rates are high, instead, I will be more likely to deposit my money in the bank for a safe return and less risk-taking.
Inflation, intended as a generalized and prolonged increase in prices that leads to a decrease in the purchasing power of money, can also be a symptom of an economy that is overheating, therefore an increase in rates represents an attempt to cool off the economy, though without falling into a recession, and bring inflation to controllable levels. Indeed, experts believe that current inflation is largely caused by the resumption of production activities following the post-pandemic reopening and by the rise in energy prices, caused both by the increased demand for production and by the war in Ukraine. Moderate inflation is usually seen in the presence of healthy economic growth but high inflation is the specter that erodes the purchasing power of employees and is to avoid at all costs.