Inflation is when prices rise, reducing the purchasing power of your money. When it happens slowly, it’s manageable. But when it surges, it can disrupt savings, wages, business planning, and economic growth. That’s when central banks step in.
Why does inflation happen?
Inflation occurs when demand outpaces supply. That can happen for several reasons:
In most economies, some inflation is healthy. But when it rises too fast or stays high for too long, it eats into incomes and savings and can trigger uncertainty.
“Inflation erodes confidence in the economy. It hits the most vulnerable households hardest and distorts decision-making across the board.”
— Dr. Clara Portman, Global Monetary Policy Expert
The central bank’s main mission
Central banks, like the Federal Reserve in the U.S. or the Bank of England in the UK, are tasked with keeping prices stable. Their main tool is monetary policy, which controls the supply of money and the cost of borrowing.
The goal is to slow inflation without causing a recession — a process often called a “soft landing.”
“Central banks are walking a tightrope. Act too slowly, and inflation gets out of control. Act too aggressively, and you risk stalling the economy.”
— Richard Nephew, former U.S. sanctions and monetary policy adviser
Tools central banks use to fight inflation
Raising interest rates
This is the primary lever for most central banks. Higher interest rates make it more expensive to borrow and more attractive to save.
This can lead to:
“Interest rates are the brake pedal of the economy, push too hard and you stall; too soft and you slide.”
— Ahmed El-Masri, Trade and Geopolitics Analyst
In the U.S., the Federal Open Market Committee (FOMC) sets a target range for the federal funds rate, and uses supporting tools like the interest on reserves and overnight repurchase agreements to guide the market to that range.
Open Market Operations (OMO)
This involves buying or selling government securities to influence the money supply:
Selling bonds pulls cash out of the system, raising rates and tightening financial conditions
Buying bonds injects money, which lowers rates and stimulates growth (used in deflationary environments)
OMO helps control short-term liquidity and keeps inflation aligned with central bank targets.
Reserve requirements
Though used less often today, some central banks can adjust how much money banks must keep in reserve. If reserve requirements go up:
In the U.S., this tool has been set to 0% since 2020, but the Federal Reserve retains the authority to adjust it again if needed.
The discount rate
This is the interest rate charged by the central bank to commercial banks that borrow directly from it.
A higher discount rate:
It's a supplementary tool, but part of the overall framework.
Forward guidance
Central banks use public statements to shape expectations.
For example, if a central bank hints that rates will stay high for a while, markets may adjust accordingly, even before any action is taken.
“Guidance matters. A well-communicated strategy can do half the job before a rate hike even takes effect.”
— Marianne Leclerc, EU monetary policy advisor
Clarity builds credibility, and that anchors long-term inflation expectations.
Currency management (selectively used)
A stronger currency makes imports cheaper. This can help reduce imported inflation, especially when energy or food prices are rising globally.
Some central banks may intervene in foreign exchange markets or use interest rates to influence currency strength, although this is typically used in tandem with other policies.
Inflation targeting: setting the goal
Many central banks operate under an inflation-targeting regime, where they aim to keep inflation around a specific figure, usually 2% per year.
The idea is to:
For instance, the Bank of England has had a 2% inflation target since 1992. If inflation overshoots, they raise interest rates. If it undershoots, they may lower them.
“A credible target isn’t just a number — it’s a signal to everyone in the economy about what the central bank is willing to do.”
— Shohini Ghose, Economic Policy Researcher
What about price controls?
Historically, some governments have tried using price or wage controls, setting caps on how much certain goods can cost.
While this may offer temporary relief, most economists view it as unsustainable in the long term. It can lead to shortages, distortions, and black markets.
Modern central banks prefer market-based tools, like interest rate adjustments, which target inflation at the source, demand and money supply.
Why it’s hard to fight inflation
Controlling inflation isn’t instant. It often takes 12 to 24 months for the full effects of higher interest rates to ripple through the economy.
Other challenges include:
“Inflation control isn’t about flipping a switch — it’s about managing a moving target while the ground keeps shifting.”
— Dr. Clara Portman
The bottom line
Central banks use a mix of interest rate policy, liquidity management, reserve requirements, and communication to control inflation. Their aim is to slow down price growth without pushing the economy into recession, a delicate balance.
While no tool is perfect, monetary policy remains the most effective mechanism we have for keeping inflation in check over time.
And while inflation is always influenced by global forces, credible, well-communicated central bank actions remain essential to maintaining economic stability at home.
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