# R10 | moonshotai/kimi-k3 | run 2

## Prompt

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

## Response

Inflation arises from three forces—demand outstripping supply (demand-pull), rising production costs or supply constraints (cost-push), and people's expectations about future inflation—which feed back into wage and price decisions [Cleveland Fed](https://www.clevelandfed.org/center-for-inflation-research/inflation-explained-your-guide-to-inflation-basics/what-causes-inflation). Central banks control it primarily by adjusting short-term interest rates to stimulate or restrain overall demand, supported by tools like asset purchases and forward guidance [Federal Reserve](https://www.federalreserve.gov/aboutthefed/fedexplained/monetary-policy.htm). When no shocks are present, inflation settles near an underlying level of about 2 percent [Cleveland Fed](https://www.clevelandfed.org/center-for-inflation-research/inflation-explained-your-guide-to-inflation-basics/what-causes-inflation).

## What Causes Inflation

- **Demand-pull inflation:** Occurs when growing demand for goods and services outpaces the economy's capacity to supply them [Cleveland Fed](https://www.clevelandfed.org/center-for-inflation-research/inflation-explained-your-guide-to-inflation-basics/what-causes-inflation).
- **Cost-push inflation:** Occurs when production costs rise notably or goods can't be produced in sufficient quantities to meet demand [Cleveland Fed](https://www.clevelandfed.org/center-for-inflation-research/inflation-explained-your-guide-to-inflation-basics/what-causes-inflation).
- **Inflation expectations:** Beliefs about future inflation shape wage demands and pricing decisions, which in turn influence actual inflation—making expectations a self-reinforcing driver [Cleveland Fed](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's statutory mandate—the dual mandate—is to promote maximum employment, stable prices, and moderate long-term interest rates [Federal Reserve](https://www.federalreserve.gov/monetarypolicy/monetary-policy-what-are-its-goals-how-does-it-work.htm). Its main instruments:

| Tool | How It Works |
|---|---|
| Federal funds rate target | The primary policy lever; raising it tightens credit and cools demand, lowering it eases conditions to spur demand [Fed Explained](https://www.federalreserve.gov/aboutthefed/fedexplained/monetary-policy.htm) |
| Interest on reserve balances (IORB) | Banks won't lend below the rate they earn on reserves at the Fed, so IORB anchors the federal funds rate near its target [Federal Reserve](https://www.federalreserve.gov/monetarypolicy/monetary-policy-what-are-its-goals-how-does-it-work.htm) |
| Overnight reverse repurchase facility | A supplementary rate that helps keep short-term rates within the target range [Fed Explained](https://www.federalreserve.gov/aboutthefed/fedexplained/monetary-policy.htm) |
| Quantitative easing | Large-scale asset purchases used when additional stimulus is needed [Fed Explained](https://www.federalreserve.gov/aboutthefed/fedexplained/monetary-policy.htm) |
| Forward guidance | Shaping public expectations about future policy actions [Fed Explained](https://www.federalreserve.gov/aboutthefed/fedexplained/monetary-policy.htm) |

Rate changes transmit through the economy via the prime rate and benchmarks for mortgages, credit cards, and car loans—higher rates make borrowing costlier, reducing demand, while lower rates encourage household and business spending [Cleveland Fed](https://www.clevelandfed.org/center-for-inflation-research/inflation-explained-your-guide-to-inflation-basics/what-causes-inflation).

## Why Credibility Matters

The Fed announced a 2 percent inflation goal in 2012; when households and firms trust that target, expectations stay "well-anchored," and workers and firms are less likely to chase temporary price increases with wage demands and price hikes—reducing the risk of a wage-price spiral [Cleveland Fed](https://www.clevelandfed.org/center-for-inflation-research/inflation-explained-your-guide-to-inflation-basics/what-causes-inflation). Expectations became unanchored in the 1970s, illustrating that restoring price stability is far costlier once high inflation is believed to be persistent [Cleveland Fed](https://www.clevelandfed.org/center-for-inflation-research/inflation-explained-your-guide-to-inflation-basics/what-causes-inflation).

Recent scholarship frames these approaches as complementary rather than competing: while interest-rate setting is often the superior instrument, a monetarist pillar and fiscal support remain essential, and at times exchange-rate pegs or debt monetization are unavoidable [AEA Journal](https://www.aeaweb.org/articles?id=10.1257%2Fjel.20251429). Stagflation—high inflation with weak growth—remains the hardest case, since raising rates to curb inflation can further suppress output [Cleveland Fed](https://www.clevelandfed.org/center-for-inflation-research/inflation-explained-your-guide-to-inflation-basics/what-causes-inflation).

Would you like a deeper look at how quantitative easing works or at historical episodes like the 1970s stagflation?
