The central banks, being the key to economic stability, are mainly responsible for inflation control. Central banks have the power to use the tools of monetary policy like interest rates and open market operations to control inflationary pressures. This, therefore, helps to keep the prices stable and the economic growth sustainable.
How do central banks control inflation?
Central banks use different methods to manage inflation. It is essential for keeping the economy steady and saving purchasing power. The ability of central banks to control inflation is the key to sustainable economic growth and maintaining economic stability. The welfare of households and businesses is also essential.
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Raising interest rates
The focal point of the central banks is the adjusting of interest rates. Central banks soar the benchmark interest rate. It makes borrowing more costly and hence consumer spending and investment drop down. Thus, the decrease in spending controls the demand-pull inflation, in turn, which stabilises the economy’s overheating.
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Entering the currency market
The central banks may act in the currency markets to control the exchange rates which subsequently change the inflation. The domestic currency becomes cheaper due to the process of selling it for foreign currency. This, in turn, makes the imports cheap. So, this measure can be used to overcome the problem of cost-push inflation by decreasing the prices of imported merchandise and services.
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Tightening monetary policy
Central banks can regulate monetary policy by decreasing the money supply. The procedure of lowering interest rates can be accomplished by employing many actions. For instance, selling government securities in open market operations is one such action. Through the limitation of the credit and liquidity supply to the financial system, the central banks strive to limit spending and investment activities. So, it helps control inflationary situations.
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Setting the reserve requirements
The Central banks impose commercial banks to keep a certain percentage of their deposits as reserves. Through changes in these conditions, central banks control the volume of money that banks can lend, resulting in overall spending and inflation.
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Introducing quantitative easing (QE) programs
In the case of recessions or low inflation periods, central banks may set up QE programs. This means buying government securities or any other assets to add liquidity to the economy. It accelerates spending and lending. It is the main way of fighting down the deflationary pressures and increasing the inflation.
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Exchange rate policies
Central banks might take part in the currency markets to affect the exchange rates. This way, the price of the imports and the inflation can be affected. Besides, by increasing or decreasing the interest rates or using foreign exchange operations, central banks strive to keep the exchange rates stable which, in turn, affects inflation.
Besides, central banks employ monetary policy tools such as the modification of interest rates to directly control borrowing costs and consumer spending. This will in turn adjust inflationary pressures.
Conclusion
Central banks use a variety of tools to control inflation. They include reserve requirements, quantitative easing and exchange rate policies. Consequently, they aim to keep the prices stable and to stimulate economic development.
