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Monetary policy in inflation control through theory and practice - Coggle…
Monetary policy in inflation control through theory and practice
Monetary policy tools and
how they affect inflation
Non-traditional tools
Forward Guidance
: Communicate future low rates → raise spending now → lift inflation expectations
Negative Interest Rates
: Penalize excess reserves → encourage lending → support inflation in low-growth settings
Quantitative Easing (QE)
: Buy long-term assets → boost liquidity → stimulate economy → raise inflation
Traditional tools
Reserve requirement ratio:
-> Raise → less lending → lower inflation
-> Lower → more lending → higher inflation
Discount Rate:
-> Higher rate → less borrowing → control inflation
-> Lower rate → more borrowing → potential inflation
Open Market Operations (OMO):
-> Buy bonds → inject money → raise inflation
-> Sell bonds → absorb money → reduce inflation
Interest on reserves:
-> High interest → banks hold reserves → slow inflation
-> Low interest → banks lend more → risk of inflation
Overview of monetary policy
Objectives of monetary policy
Economic growth
Stability of financial market
Interest-rate stability
High employment and output stability
Stability in foreign exchange market
Price stability
(Primary goal)
Role in inflation control
If inflation rises above target:
Central banks tighten monetary policy by increasing interest rates -> Reduce borrowing and Lower consumption & investment
Most modern central banks target the rate of inflation in a country as their primary metric for monetary policy
If inflation falls and economy slows:
The central bank will lower interest rates
-> Encourage borrowing and Boost demand
Definition:
Central bank tools to control money supply and promote growth