What are the main difficulties the Central Bank might encounter in attempting to reduce the rate of inflation?

The Central Bank can use various different methods for reducing inflation. At the moment, the Bank Of England primarily uses changing the rate of interest (base rate) to keep inflation within the govt target of 2% + / - 1 The Monetary Policy Committee meet every month to set interest rates based on future predictions of inflation. Monetary policy is pre-emptive; this means they try and reduce inflationary pressures before they build up.

To reduce inflation the MPC can increase the base interest rate. This will lead to a general rise in interest rates. This will make borrowing more expensive and savings more attractive, therefore consumption and investment will fall, causing AD to increase at a slower rate and help reduce inflation.

The first difficulty is predicting future inflation trends. According to current economic trends there may be no threat of rising inflation and therefore the MPC will leave interest rates unchanged. However, if there is an unexpected increase in AD, (e.g. ... more.

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