# R10 | openai/gpt-5.4-mini | run 2

## Prompt

What causes inflation, and what tools do central banks use to control it? Summarize and cite authoritative sources.

## Response

Inflation usually rises when overall demand outpaces supply, when costs like energy or wages jump, when expectations of future inflation become embedded, or when monetary and fiscal policy are too loose for current conditions. Central banks primarily fight inflation by tightening monetary policy, especially by raising interest rates and shrinking or slowing money creation. ([bis.org](https://www.bis.org/topic/inflation.htm?utm_source=openai))

## What causes inflation

- **Demand exceeding supply:** When households, firms, or governments spend faster than the economy can produce, prices tend to rise. ([imf.org](https://www.imf.org/en/about/factsheets/sheets/2023/monetary-policy-and-central-banking?utm_source=openai))
- **Supply shocks:** Bottlenecks, energy spikes, food shocks, or other disruptions can raise production costs and push prices up. The BIS notes that the inflation surge since 2021 initially reflected supply bottlenecks and higher energy prices. ([bis.org](https://www.bis.org/topic/inflation.htm?utm_source=openai))
- **Loose monetary conditions:** If interest rates are too low for too long, credit and spending can expand faster than supply, increasing inflation pressure. ([imf.org](https://www.imf.org/en/about/factsheets/sheets/2023/monetary-policy-and-central-banking?utm_source=openai))
- **Inflation expectations:** If businesses and households expect higher inflation, they may raise prices and wages in advance, making inflation more persistent. ([bis.org](https://www.bis.org/publ/bppdf/bispap49.htm?utm_source=openai))

## Main tools central banks use

| Tool | How it works | Typical inflation effect |
|---|---|---|
| **Policy interest rate** | Central banks raise or lower short-term rates to influence borrowing, spending, and investment. | Higher rates cool demand and reduce inflation. ([imf.org](https://www.imf.org/en/about/factsheets/sheets/2023/monetary-policy-and-central-banking?utm_source=openai)) |
| **Open market operations / asset purchases or sales** | Buying or selling securities changes bank reserves and short-term rates. | Selling assets or stopping purchases tightens conditions. ([imf.org](https://www.imf.org/en/about/factsheets/sheets/2023/monetary-policy-and-central-banking?utm_source=openai)) |
| **Reserve requirements** | Changes how much banks must hold in reserve. | Tighter requirements can restrict lending. ([federalreserve.gov](https://www.federalreserve.gov/monetarypolicy/policytools.htm?utm_source=openai)) |
| **Interest on reserves / overnight facilities** | Sets the return on reserves or overnight lending, helping steer market rates. | Helps keep policy rates near the target. ([federalreserve.gov](https://www.federalreserve.gov/monetarypolicy/policytools.htm?utm_source=openai)) |
| **Forward guidance** | Communicates expected future policy path. | Shapes expectations and financial conditions. ([federalreserve.gov](https://www.federalreserve.gov/aboutthefed/fedexplained/monetary-policy.htm?utm_source=openai)) |
| **Unconventional tools** | Large-scale asset purchases, negative rates in some cases, or liquidity facilities. | Used when standard rate cuts are limited. ([imf.org](https://www.imf.org/en/about/factsheets/sheets/2023/monetary-policy-and-central-banking?utm_source=openai)) |

## Bottom line

Central banks control inflation mainly by **tightening financial conditions** so demand slows toward the economy’s supply capacity. Their standard tool is the **policy interest rate**, supported by market operations, reserve-related tools, and communication. ([imf.org](https://www.imf.org/en/about/factsheets/sheets/2023/monetary-policy-and-central-banking?utm_source=openai))

Would you like a shorter version, or a version tailored to the U.S. Federal Reserve specifically?
