Policies to Control Inflation

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    Policies to Control Inflation

    Coast-Push Inflation

    • If a government believes that inflation is caused by excessive wage rises, then it may seek to implement measures which halt wage rises
      • In the public sector, it can simply do this by decreasing the amount of government spending allocated to public workers’ pay.
      • For the private sector, the government can implement policies that directly relate to wage increases
        • However, this can create inflexibility in the labour market, as new companies cannot attract workers with higher wages.
      • A government may also reduce corporation tax or subsidise firms
        • This not only stimulates investment, but also means firms can cover rising costs without putting their prices up.
        • However, it could also mean that firms get reliant upon the subsidies, and do not strive to keep their costs down.

    Demand-Pull Inflation

    • To reduce demand-pull inflation, a government may use deflationary fiscal and/or monetary policy
    • These measures will reduce aggregate demand, and hence the price level
      • A government could achieve this by raising income tax, which would reduce people’s ability to spend
      • AD could also be reduced by raising the interest rate, as this will reduce consumption, investment and net exports.

    Inflation Targeting

    • Inflation targeting can lower the chance of both demand-pull and cost-push inflation by reducing the expectations of inflation
    • Inflation is caused by how people act, and so if people have confidence that the central bank can meet their target of inflation, they will act in a way that does not cause inflation

     

    • In the long run, a government would seek to reduce inflationary pressure by increasing aggregate supply
      • If AD increases – a move that would normally increase the price level – but AS increase in line with it, then the price level will remain unchanged
        • This results in the fact that consumers would be able to enjoy more goods and services without inflation and/or balance of payments problems
      • This increase of AS is likely to be the result of successful supply-side policies, as they’re more of a long-run approach to controlling inflationary pressure.
        • Long-run SSP do not have adverse short-term effects on employment and output that deflationary fiscal and monetary policies may.

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