system
Given the following post, respond as if you're commenting on Reddit:
human
ELI5: What is inflation/interest rates and how do they affect an economy in the long run?

Reading about economic history. I have a vague idea about what "inflation" and "interest rates" mean, but I don't know how exactly are they supposed to affect the economy positively/negatively. 

From what I've heard—both inflation/deflation and higher/lower interest rates can be good or bad for the economy, depending on the situation. How and why does this happen?
gpt
These are related to how a monetary based system works. One way to look at it is that interest rates are a "tool" and the inflation is one of the "outcomes" the tool is supposed to manage. 

It gets a little bit difficult to picture but a core idea is the idea of purchasing power. For example, say you have $100 and the current (nominal) interest rate (controlled by the Central Bank more or less) is 10%. This means saving this $100 results in $110 after 1 year. Meanwhile inflation is 5%. This means something that costs $100 today costs $105 in 1 year. In this particular scenario, saving for 1 year increases your purchasing power since $110 is greater than $105. It can be said that the real interest rate (ie accounting for inflation) is positive - this generally benefits saving over consumption. 

However too high real interest rates, causes too many people to save and this has the detrimental effect that overall consumption decreases (meaning the economy shrinks) - this is called the 'paradox of savings'. The bad thing is that it is possible to get into a vicious cycle where initially sellers reduce their prices (to increase sales) and this causes deflation. If this cycle continues, sellers shut down factories and more people are unemployed and this causes further shrinking of demand - a vicious downward cycle. This is why deflation is almost universally considered a very bad thing. Central banks/governments will do everything to avoid this. 

On the other hand if real interest rates are low or negative, it induces more current consumption (holding cash is bad) which stimulates the economy but at the cost of people who are earning fixed incomes. (eg people with not much savings or who are retired living off their savings). 

Most of the time, governments will target a low inflation rate (say around 2%) which gives them some room to react if something happens. They do so by controlling the nominal interest rate to boost the economy (lower rates) or slow down the economy (increase rates) In extraordinary situations (like COVID-19) the interest rate tools are not very effective and the government will go to more extraordinary measures (directly pumping money into economy) to keep things from getting too bad (it will be bad - but hopefully not as bad).

Bottom line though, it is important to know that these are monetary actions and are indirectly used to control the "real" economy - ie actual goods and services, trade, employment. The real economy usually grows - more people join the workforce (due to population increases), technological and productivity improvements, new inventions etc etc. This is why a healthy economy usually needs a bit of inflation and monetary base growth to keep up.