Final answer:
To combat higher-than-expected inflation, a central bank could use open market operations to sell government bonds, effectively reducing the money supply and increasing interest rates, which can lead to disinflation.
Step-by-step explanation:
When inflation rates exceed expectations, a central bank may need to implement a disinflation policy. This involves slowing down the rate of inflation to stabilize the economy. One of the central bank's primary tools for achieving this is through open market operations.
In the context of a limited reserves framework, a central bank would typically conduct open market operations by selling government bonds to the banks. This process effectively reduces the banks' reserves because they have to pay for these bonds, and as a result, the money supply in the economy is decreased. When the money supply is reduced, it decreases the amount of money available for lending and investment, leading to higher interest rates. These higher interest rates can slow down borrowing and spending, which helps to reduce inflationary pressures.
Open market operations are a preferred tool for central banks because they can be used with flexibility and precision. Unlike changing reserve requirements or the discount rate, which are also traditional tools, open market operations can be implemented more frequently and with specific target amounts, allowing central banks to fine-tune their monetary policy in response to changing economic conditions.
Although the central bank's goal is to guard against deflation, it must also balance this with strategies to prevent excessive inflation. Open market operations aimed at disinflation help to ensure price stability by curbing the inflation rate to an acceptable level without causing unnecessary harm to the economy.
It's important to note that while the central bank is focusing on disinflation, it must also consider the potential risks associated with deflation, such as those experienced during the Great Depression. However, moderate levels of deflation do not necessarily lead to economic disaster and need to be assessed in the context of the overall economic environment.