Why do central banks raise interest rates to curb inflation?

Christine Lagarde China Usa Britain Sweden South Korea Eu France Norway Australia Canada Russia Ukraine European Union Refugees Swimming

20.06.2022 - 18:33

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euronews.com:

It's all going up: electricity, diesel, vegetables, the Internet, hotels, flights, and now, interest rates.

The war in Ukraine, the on-and-off lockdowns in China, a persistent power crunch and disrupted production chains have bumped into a huge appetite for goods and services, upsetting the delicate balance between supply and demand and driving prices to record highs.

In an almost synchronised manner, central banks from all around the world are rushing to raise their key interest rates in a bid to tame soaring inflation, which, much to their dismay, continues to break monthly records.

The European Central Bank (ECB) became one of the latest institutions to shift monetary policy, closing a long chapter of negative rates dating back to the worst years of the EU's sovereign debt crisis.

Its counterparts in the United Kingdom, Sweden, Norway, Canada, South Korea and Australia have all taken similar steps in recent months, reacting to daunting inflation readings. In one single announcement, the Federal Reserve of the United States hiked rates by 0.75 percentage points, the largest increase since 1994.

But what exactly is the rationale behind this move?

Central banks are public institutions of a unique nature: they are independent, non-commercial entities tasked with managing the currency of a country or, in the case of the ECB, a group of countries.

They have exclusive powers to issue banknotes and coins, control foreign reserves, act as emergency lenders and guarantee the good health of the financial system.

A central bank's prime mission is to ensure price stability. This means they need to control both inflation – when prices go up – and deflation – when prices go down.

Deflation depresses the economy and fuels unemployment, so