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How do central banks control inflation? A guide for the perplexed

Author

Listed:
  • Laura Castillo-Martinez

    (Duke University)

  • Ricardo Reis

    (London School of Economics (LSE))

Abstract

Central banks have a primary goal of price stability. They pursue it using tools that include the interest they pay on reserves, the size and the composition of their balance sheet, and the dividends they distribute. We describe the economic theories that justify the central bank’s ability to control inflation and discuss their relative effectiveness, in light of both theory and the historical record. We present alternative approaches as consistent with each other, as opposed to conflicting ideological camps. While interest-rate setting is often superior, having both a monetarist pillar and fiscal support is essential, and at times pegging the exchange rate or monetizing the debt is inevitable.

Suggested Citation

  • Laura Castillo-Martinez & Ricardo Reis, 2024. "How do central banks control inflation? A guide for the perplexed," Discussion Papers 2433, Centre for Macroeconomics (CFM).
    • Handle: RePEc:cfm:wpaper:2433
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    File URL: https://www.lse.ac.uk/CFM/assets/pdf/CFM-Discussion-Papers-2024/CFMDP2024-33-Paper.pdf
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    More about this item

    Keywords

    monetary policy; policy rules; determinacy; effectiveness;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination

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