# R10 | z-ai/glm-5.2 | run 1

## Prompt

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

## Response

Inflation arises from imbalances between demand and supply, rising production costs, or unanchored expectations about future price levels. Central banks primarily control inflation by adjusting the federal funds rate, which influences borrowing costs and overall economic demand, supported by additional tools like interest on reserves and forward guidance.

## What Causes Inflation?

Inflation is driven by three main factors: demand, supply, and inflation expectations [clevelandfed.org](https://www.clevelandfed.org/center-for-inflation-research/inflation-explained-your-guide-to-inflation-basics/what-causes-inflation).

**Demand-Pull Inflation**
This occurs when aggregate demand for goods and services grows faster than the economy's capacity to supply them. The resulting competition among buyers pushes prices upward [clevelandfed.org](https://www.clevelandfed.org/center-for-inflation-research/inflation-explained-your-guide-to-inflation-basics/what-causes-inflation).

**Cost-Push Inflation**
This type of inflation results from sharp increases in production costs or supply shortages that prevent producers from meeting demand. Adverse supply shocks force producers to raise prices, leading to higher overall inflation and lower economic output [clevelandfed.org](https://www.clevelandfed.org/center-for-inflation-research/inflation-explained-your-guide-to-inflation-basics/what-causes-inflation).

**Inflation Expectations**
Inflation is partly self-fulfilling. If consumers expect higher prices, they may accelerate purchases to avoid future costs. Similarly, businesses may preemptively raise prices to cover anticipated input cost increases. These collective actions can drive actual inflation higher [clevelandfed.org](https://www.clevelandfed.org/center-for-inflation-research/inflation-explained-your-guide-to-inflation-basics/what-causes-inflation). Central banks work to keep these expectations "well-anchored" around a credible target, such as the Fed's 2% goal, to prevent temporary shocks from causing persistent inflation [clevelandfed.org](https://www.clevelandfed.org/center-for-inflation-research/inflation-explained-your-guide-to-inflation-basics/what-causes-inflation).

## How Central Banks Control Inflation

The Federal Reserve conducts monetary policy to achieve its dual mandate of maximum employment and stable prices [federalreserve.gov](https://www.federalreserve.gov/monetarypolicy/monetary-policy-what-are-its-goals-how-does-it-work.htm). It manages inflation by spurring or restraining overall demand for goods and services [federalreserve.gov](https://www.federalreserve.gov/monetarypolicy/monetary-policy-what-are-its-goals-how-does-it-work.htm).

| Tool | Description |
| :--- | :--- |
| **Federal Funds Rate** | The primary tool. The Fed sets a target range for this overnight interbank lending rate. Raising it tightens policy to fight inflation; lowering it eases policy to stimulate growth [federalreserve.gov](https://www.federalreserve.gov/aboutthefed/fedexplained/monetary-policy.htm). |
| **Interest on Reserve Balances (IORB)** | The Fed influences the federal funds rate by changing the interest rate it pays banks on reserves held at the Fed. Banks are unlikely to lend below this rate [federalreserve.gov](https://www.federalreserve.gov/monetarypolicy/monetary-policy-what-are-its-goals-how-does-it-work.htm). |
| **Overnight Reverse Repurchase (ON RRP) Rate** | Another administered rate used to help keep the federal funds rate within the target range [federalreserve.gov](https://www.federalreserve.gov/aboutthefed/fedexplained/monetary-policy.htm). |
| **Quantitative Easing** | Large-scale asset purchases used to influence financial conditions when conventional rate cuts are insufficient [federalreserve.gov](https://www.federalreserve.gov/aboutthefed/fedexplained/monetary-policy.htm). |
| **Forward Guidance** | Communication about the expected future path of policy to shape public expectations and influence financial conditions [federalreserve.gov](https://www.federalreserve.gov/aboutthefed/fedexplained/monetary-policy.htm). |

**The Transmission Mechanism**
When the Fed raises the federal funds rate, it transmits across other lending rates like mortgages and car loans, making borrowing more expensive. This reduces consumer and business spending, cooling demand and easing inflationary pressure [clevelandfed.org](https://www.clevelandfed.org/center-for-inflation-research/inflation-explained-your-guide-to-inflation-basics/what-causes-inflation). Conversely, lowering the rate makes borrowing cheaper, stimulating demand [clevelandfed.org](https://www.clevelandfed.org/center-for-inflation-research/inflation-explained-your-guide-to-inflation-basics/what-causes-inflation).

What impact do geopolitical tensions or global supply chain disruptions typically have on a central bank's ability to manage inflation?
