Government policy to control inflation
Government uses a number of policies to deal with the different types of inflation. These are:
Demand Side policies-to control demand pull inflation
Deflationary fiscal policy: This involves an increase in taxes and lowering of government spending. Increasing taxes will result in lower disposable income for household and thus less consumption. Moreover, increased taxes will result in lower profits for firms and thus less investment by firms. All these factors will lower the AD in the economy.
Deflationary monetary policy: It involves rising of interest rates and reducing money supply. Higher interest rates mean higher loan and mortgage repayments. This will deter households and firms to borrow, leading to fall in consumption and investment respectively.
Supply side policies-to control cost push inflation
It includes all those policies which aim at improving the efficient supply of goods and services. These might include:
- Imparting training and improving the education level of the workforce resulting in higher skills.
- Increase competition in all industries by removing entry barriers, thus leading to more efficiency.
Exchange rate policies to control imported inflation
This involves increasing the value of currency to reduce imported inflation. Increase currency rate will also lead to fall in demand for exports (component of AD).