# R10 | mistralai/mistral-small-2603 | run 2

## Prompt

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

## Response

Central banks target low, stable inflation—typically around 2%—and fight price spikes by adjusting interest rates, managing expectations, and sometimes deploying unconventional tools to cool or stimulate demand. Inflation springs from three core drivers: demand pulling prices up faster than supply, supply-side “cost-push” shocks (like energy price spikes), and self-fulfilling expectations of future inflation. When inflation rises, central banks tighten policy by raising short-term rates, paying interest on reserves, and tightening balance sheets; when inflation falls too low, they ease rates, expand balance sheets (quantitative easing), or offer forward guidance to lift spending and prices.

Inflation is driven by three main factors—demand, supply, and inflation expectations—and central banks use interest rates and balance-sheet tools to counteract persistent rises or falls in inflationAuthoritative sources describe inflation as driven by demand, supply, and expectations, with monetary policy (especially interest rates) used to steer inflation toward its target.

Central banks control inflation primarily by setting short-term interest rates (e.g., the federal funds rate), adjusting interest paid on reserves, and using tools like large-scale asset purchases (“quantitative easing”) and forward guidance to steer demand and expectationsWhen necessary, the Fed primarily adjusts the stance of monetary policy by changing its target range for the federal funds rate, which is transmitted via interest on reserve balances and other tools such as large-scale asset purchases and forward guidanceThe Fed’s operating tools now include the interest rate on reserve balances and the overnight reverse repurchase facility rate, used alongside quantitative easing and forward guidance to steer short-term rates and broader financial conditions.

How inflation controllers analyze and forecast inflationRecognizing demand-pull, cost-push, and expectations-based inflation is central to policy design by institutions like the Reserve Bank of AustraliaThe Cleveland Fed distinguishes demand-pull and cost-push inflation, and explains how monetary policy responds through the federal funds rate mechanism to stabilize inflation around 2 percent.

In practice, central banks communicate and justify their policy stance publicly, targeting low and stable inflation (e.g., 2% per year as measured by the PCE index) while aiming for maximum employment; they adjust settings based on labor-market indicators and incoming inflation data rather than pre-set rulesAuthoritative central-bank guidance frames the goal as low and stable inflation (around 2% as measured by PCE), aligned with broader economic conditions and communicated via policy statements.
