Central Banks has many options to try to bring down inflation.
Central Banks can raise interest rates. They can increase the level of reserves that commercial banks must hold to decrease the amount of money these banks could lend. Central Banks can also sell off some of the massive pile of bonds they acquired over the last years. When they sell their assets, they take in cash and put this to bed, decreasing the amount of money in the economy and slowing growth.
Central Banks always the so-called forward guidance. That’s when Central Bankers talk tough about what they are going to do. Investors and consumers listen to this and react without the Central banks even taking action.
So, how high can the Fed raise interest rates? In theory, the sky is the limit. We have seen interest rates of 20% and more in the early 1980s to get soaring inflation under control. That pushed other important longer term rates up and drove the economy into recession.
Let’s hope we don’t have to go there again.
Sven Franssen