How does the central bank control the rate of inflation?

The Most Senior Economist is always the Finance Minister in the country who regulates the country's economy by managing the monetary and financial policies such as:

1. Controlling the prime lending rate

2. Interbank and Repo rates.

3. Reducing the percentage of Cash Reserve Ratios (to control local banks how much to lend and borrow).

4. Fixing the borrowing limits to banks and single group of companies.

5. Suggesting measures to impose or relax custom duties on imports and exports of certain products such as Gold and other precious metals in order to balance the economy.

 

 

1. 1.       When banks lend more, the total money supply in the economy inflates. And perhaps prices for some goods and services rise, such as college tuition fees and house prices for example. When they increase lending rates the cost of capital of the borrowers increase and their demand for loan may reduce. When the bank increase the interest on term deposits people may interested in depositing the money in banks rather spending the excess money for any other thing. Hence we can surely say that central bank can control inflation by changing interest rates.

1. 2.       Govt. can’t simply print the money to finance government expenditure.  If they have any deficit Governments borrow by selling government bonds / gilts to the private sector. Bonds are a form of saving. People buy government because they assume a government bond is a safe investment. However, this assumes that inflation will remain low. If governments print money to pay off national debt, inflation would rise. This increase in inflation would reduce the value of bonds. If inflation increases, people will not want to hold bonds because their value is falling. Therefore, the government will find it difficult to sell bonds to finance the national debt. They will have to pay higher interest rates to attract investors. If the government prints too much money and inflation gets out of hand, investors will not trust the government and it will be hard for the government to borrow anything at all. Therefore, printing money could create more problems than it solves.

1. 3.       Exchange rate changes will not leads to inflation but inflation leads to change in exchange rate.  A relatively higher inflation rate in the India compared to other countries will tend to reduce the value of Indian currency.

 

the central bank regulates inflation through sell of bonds and some treasury intruments to the public and its dealers. this is usually done depending on the state of money circulation in the country .

Two things are very important in it.

- To increase Interest rate that will effect both benefit on deposit and cost of borrowing.

- To reduce or control money circulation.

Interest Rate:

Increase interest rates to reduce consumer spending (hence more saving), because inflation is caused by lots of consumer spending. Higher interest rates mean higher loan and mortgage repayments. This will deter households and firms to borrow, leading to fall in consumption and investment respectively.

 

Supply of Money:

Reducing the production or supply of money so that the currency doesn't lose more value i.e. inflation causes currencies to lose value or purchasing power.

 

Exchange Rate:

As a general rule, a country with a consistently lower inflation rate exhibits a rising currency value, as its purchasing power increases relative to other currencies. High inflation rates increases the foreign exchange rates and hence weakens the local currency. This in turn reduces the purchasing power.

 

Central banks increase the bank rates and lending rates thereby reducing the purchasing power.

Central Bank control the rate of inflation by mopping out the money in circulation.

increase the interest rate

It is the large monetary mass that is outside the banking system, to absorb this mass of money, the central bank raises the interest rate to encourage economic agents placed their money in the banks

 

the central bank controls inflation through one of the following, open market operation,special deposit,cash ratio,bank rate,funding,credit ceiling etc.

Central banks can reduce the inflation rate by adopting several monetary policy tools. These are used to control the money supply in that economy.