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Inflation occurs when an economy grows due to increased spending. Prices rise, and money loses value because it won’t buy as much as before.

Inflation can be controlled without causing a recession using contractionary​ monetary policies. There are mainly three.  

The first is to increase interest rates. Banks borrow money from the government at the Federal Reserve rate. To make money, those banks must lend money at higher rates. If the Federal Reserve increases its interest rate, banks have to increase their rates, too. Fewer people want to borrow money when it costs more. Spending drops, prices fall and inflation slows.

Another policy is to increase reserve requirements. Banks must maintain a certain amount of cash in reserve to cover withdrawals. The more money banks must hold, the less they can lend. Consumers borrow less, and spending slows.

Finally, the government can call in debts that are owed, or increase the interest that bonds pay so more investors will buy them. Both tactics take cash from the pockets of banks, investors and companies, putting the cash in the government’s pocket, for easier control.

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