How does a central bank primarily control inflation?

A central bank primarily controls inflation by managing the money supply. This is achieved through various monetary policy tools that influence the amount of money circulating in the economy. When a central bank wants to reduce inflation, it may choose to decrease the money supply, making borrowing more expensive and reducing spending and investment. This approach aims to cool down an overheating economy, where demand outstrips supply, leading to rising prices.

Conversely, if inflation is low and the economy needs stimulation, the central bank can increase the money supply. This makes credit cheaper and encourages spending and investment, which can help boost economic activity. Effective management of the money supply is crucial for maintaining price stability and fostering a healthy economic environment.

In contrast, while increasing tax rates, restricting foreign investments, and implementing trade tariffs can influence the economy, they do not serve as primary levers for controlling inflation in the same direct way that managing the money supply does. These measures may affect economic growth and competitiveness but are not the central bank's standard tools for directly addressing inflation.