The Central Bank has control over the amount of money printing that can be carried out by the banking system, without having any influence on the price of money, the quantity of deposits in the banking system, and the number of commercial banks that can provide banking services.
Since in a competitive economy many firms, especially small businesses, do not make commercial loans, the banks that issue them must, therefore, charge them a high interest rate. By setting interest rates high, the banks create a vicious circle. They create more money than they can lend and end up with more money in private hands, while at the same time keeping prices low.
What controls inflation?
Inflation means the increase in the value of a currency caused by changes in the quantity of money that the bank lends. This affects the money supply and price that the economy experiences.
What factors are decisive in determining the success of a central bank?
A central bank should have a strong legal capacity to issue banknotes. They should have the necessary knowledge and experience about money, banking, and price fluctuations to be able to monitor the progress and effect of their own initiatives.
Who decides the level of interest?
There are four main factors that determine the interest rate on banknotes issued by a central bank. The government has the power to regulate the interest rate at national level.
First is the risk of inflation. If the rate of inflation exceeds 2 percent, the government can lower the interest rate on banknotes to encourage consumption, and to protect the economy. Second is the need and right of the consumers. The lower the interest rate, the more customers will be willing to pay, and the more banks will lend. Third is the cost of capital to operate a financial institution. Lowering the interest rate leads to a greater capital available, which in turn leads to a greater loan rate, which makes lending more attractive.
Is the aim of inflation a steady gain?
A stable rate is the ultimate goal of central banks. Increasing the interest rate during the course of each cycle is the key to stability, but the rate cannot exceed its long-run limit.
Does inflation create money, or money creates inflation?
We don’t really care about whether money is created or not. One only cares if there is money and, if so, how.
How does the money supply affect money prices?
The money supply is a proxy for the money supply. In our example, the money supply
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