If the interest rate is increased to limit inflation, doesn't that increase the money supply? Because one year later, 5% of the total bond will need to be created and put into circulation.
This, in turn, would create inflation by itself.
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No it doesn’t. Bonds coupon rate (interest for bond) is not paid with newly created money but with pre existing money that already circulate in economy.
Interest itself does not lead to money creation or destruction, it’s just transfer of money from one party to another. In fact bond itself is also just transfer unless it is bought by central bank with newly created reserves.
answered May 22, 2023 at 18:22