Methods to control inflation

Some of the important measures to control inflation are as follows: Inflation is caused by the failure of aggregate supply to equal the increase in aggregate demand. Inflation can, therefore, be controlled by increasing the supplies of goods and services and reducing money incomes in order to control aggregate demand. The various methods are usually grouped under three heads:

Methods to control inflation

Monetarists assume that the velocity of money is unaffected by monetary policy at least in the long runand the real value of output is determined in the long run by the productive capacity of the economy. Under these assumptions, the primary driver of the change in the general price level is changes in the quantity of money.

With exogenous velocity that is, velocity being determined externally and not being influenced by monetary policythe money supply determines the value of nominal output which equals final expenditure in the short run.

In practice, velocity is not exogenous in the short run, and so the formula does not necessarily imply a stable short-run relationship between the money supply and nominal output. However, in the long run, changes in velocity are assumed to be determined by the evolution of the payments mechanism.

If velocity is relatively unaffected by monetary policy, the long-run rate of increase in prices the inflation rate is equal to the long-run growth rate of the money supply plus the exogenous long-run rate of velocity growth minus the long run growth rate of real output. For example, investment in market productioninfrastructure, education, and preventive health care can all grow an economy in greater amounts than the investment spending.

In this view, while generally grounded in monetarism, future expectations and strategies are important for inflation as well. A core assertion of rational expectations theory is that actors will seek to "head off" central-bank decisions by acting in ways that fulfill predictions of higher inflation.

This means that central banks must establish their credibility in fighting inflation, or economic actors will make bets that the central bank will expand the money supply rapidly enough to prevent recession, even at the expense of exacerbating inflation. Thus, if a central bank has a reputation as being "soft" on inflation, when it announces a new policy of fighting inflation with restrictive monetary growth economic agents will not believe that the policy will persist; their inflationary expectations will remain high, and so will inflation.

On the other hand, if the central bank has a reputation of being "tough" on inflation, then such a policy announcement will be believed and inflationary expectations will come down rapidly, thus allowing inflation itself to come down rapidly with minimal economic disruption.

Austrian School and Monetary inflation The Austrian School stresses that inflation is not uniform over all assets, goods, and services.

Inflation depends on differences in markets and on where newly created money and credit enter the economy. Real bills doctrine The real bills doctrine asserts that banks should issue their money in exchange for short-term real bills of adequate value.

Currency and banking schools of economics argue the RBD, that banks should also be able to issue currency against bills of trading, which is "real bills" that they buy from merchants.

This theory was important in the 19th century in debates between "Banking" and "Currency" schools of monetary soundness, and in the formation of the Federal Reserve.

In the wake of the collapse of the international gold standard postand the move towards deficit financing of government, RBD has remained a minor topic, primarily of interest in limited contexts, such as currency boards.

It is generally held in ill repute today, with Frederic Mishkina governor of the Federal Reserve going so far as to say it had been "completely discredited. In the 19th century the banking schools had greater influence in policy in the United States and Great Britain, while the currency schools had more influence "on the continent", that is in non-British countries, particularly in the Latin Monetary Union and the earlier Scandinavia monetary union.

General[ edit ] An increase in the general level of prices implies a decrease in the purchasing power of the currency. That is, when the general level of prices rise, each monetary unit buys fewer goods and services. The effect of inflation is not distributed evenly in the economy, and as a consequence there are hidden costs to some and benefits to others from this decrease in the purchasing power of money.

For example, with inflation, those segments in society which own physical assets, such as property, stock etc. Their ability to do so will depend on the degree to which their income is fixed. For example, increases in payments to workers and pensioners often lag behind inflation, and for some people income is fixed.

Also, individuals or institutions with cash assets will experience a decline in the purchasing power of the cash. Increases in the price level inflation erode the real value of money the functional currency and other items with an underlying monetary nature.

Debtors who have debts with a fixed nominal rate of interest will see a reduction in the "real" interest rate as the inflation rate rises. The real interest on a loan is the nominal rate minus the inflation rate. Any unexpected increase in the inflation rate would decrease the real interest rate.

Banks and other lenders adjust for this inflation risk either by including an inflation risk premium to fixed interest rate loans, or lending at an adjustable rate.

Negative[ edit ] High or unpredictable inflation rates are regarded as harmful to an overall economy. They add inefficiencies in the market, and make it difficult for companies to budget or plan long-term. Inflation can act as a drag on productivity as companies are forced to shift resources away from products and services to focus on profit and losses from currency inflation.

For instance, inflated earnings push taxpayers into higher income tax rates unless the tax brackets are indexed to inflation. With high inflation, purchasing power is redistributed from those on fixed nominal incomes, such as some pensioners whose pensions are not indexed to the price level, towards those with variable incomes whose earnings may better keep pace with the inflation.

There can also be negative impacts to trade from an increased instability in currency exchange prices caused by unpredictable inflation.

Cost-push inflation High inflation can prompt employees to demand rapid wage increases, to keep up with consumer prices.

In the cost-push theory of inflation, rising wages in turn can help fuel inflation. In the case of collective bargaining, wage growth will be set as a function of inflationary expectations, which will be higher when inflation is high. This can cause a wage spiral.

Social unrest and revolts Inflation can lead to massive demonstrations and revolutions.Control of money supply – Monetarists argue there is a close link between the money supply and inflation, therefore controlling money supply can control inflation.

Supply-side policies – policies to increase competitiveness and efficiency of the economy, putting downward pressure on long-term costs.

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Methods to Control Inflation- Monetary Methods. Credit caninariojana.comtization of currency e Issue of new currency of a smaller denomination of higher value; e.g. a . The methods of credit control described above are known as quantitative or general methods as they are meant to control the availability of credit in general.

Thus, bank rate policy, open market operations and variation in cash reserves ratio expand or contract the availability of credit for all purposes. In fact, inflation in an economy is a mixture of demand-pull and cost-push factors. Thus, for controlling infla­tion, policymakers employ three methods: (i) monetary measures; (ii) fiscal measures; and (iii) non-monetary measures.

METHODS TO CONTROL INFLATION Inflation in general terms means expansion. In the context of prices inflation means continuous rise in price level. There are broadly two ways of controlling inflation in an economy: 1). Monetary measures and. 2). Fiscal measures.

I).Monetary Measures The most important and commonly used method to control inflation is monetary policy of the Central Bank.

Methods to control inflation

In fact, inflation in an economy is a mixture of demand-pull and cost-push factors. Thus, for controlling infla­tion, policymakers employ three methods: (i) monetary measures; (ii) fiscal measures; and (iii) non-monetary measures.

Methods to Control Inflation | Essay Example