Question

the us central bank has the stated goal of promoting sustainable economic growth, maintaining stable price level and promoting max employment. if the federal reserve believes that us economy is beginning to grow to fast and create too much inflation, what could they do to slow down the economy a bit in order to maintain a stable price level in sustainable economic growth

Answer 1

The central bank can control the inflation with a contractionary monetary policy. This can be achieved by increasing the interest rates. Higher interest rates make the cost of funds higher. This makes borrowing more expensive and curbs borrowing. And this helps to reduce the spending because consumers prefer to save more rather than spend. The result is a fall in the general demand which pulls the prices downward and helps to control inflation.

The central bank can also increase reserve requirements which reduces the amount of disposable funds with the bank’s available for lending. Again the borrowings decrease and has a negative the impact on inflation.

The central bank can also increase the tax rates which will reduce the disposable income in the hands of consumers thus resulting in decline in the demand in the economy. Various other measures such as reduction of budget deficit and direct control of money supply can also be used by central bank for controlling inflation.