Methods to Control Inflation

Readers Question can inflation be reduced or eliminated in Nigeria. why or why not?

After experiencing inflation of 50% plus in the mid 1990s, inflation in Nigeria is currently 11.5% (2009) (link) GDP growth is currently about 3.8% (2009)

I don’t know much about the Nigerian economy. But, with these statistics, we can consider ways that inflation could be reduced.

Monetary Policy

With growth of 3.8%, demand in the economy could be growing faster than capacity can grow to meet it. This leads to inflationary pressures. We can term this demand pull inflation. Therefore, reducing the growth of Aggregate demand, should reduce inflationary pressures.

The Central bank could increase interest rates. Higher rates make borrowing more expensive and saving more attractive. This should lead to lower growth in consumer spending and investment. (see more on higher interest rates)

see also: Evaluation of monetary policy in controlling inflation

A higher interest rate should also lead to higher exchange rate, which helps to reduce inflationary pressure by

  • making imports cheaper.
  • Reducing demand for exports and
  • Increasing incentive for exporters to cut costs.

inflation-interest-rates

Interest rates were increased in the late 1980s / 1990 to try and control the rise in inflation

Fiscal Policy

The government can increase taxes (such as income tax and VAT) and cut spending. This improves the budget situation and helps to reduce demand in the economy.

Both these policies reduce inflation by reducing growth of Aggregate Demand. In Nigeria’s case, the economy seems to be growing reasonably strongly. Therefore, we can reduce inflationary pressures without causing a recession.

If Nigeria had high inflation and negative growth, then reduce aggregate demand would be more unpalatable as reducing inflation would lead to lower output and higher unemployment. They could still reduce inflation, but, it would be much more damaging to the economy.

Other Policies to Reduce Inflation

Wage Control

If inflation is caused by wage inflation (e.g. powerful unions bargaining for higher real wages), then limiting wage growth can help to moderate inflation. Lower wage growth helps to reduce cost push inflation, and helps to moderate demand pull inflation.

However, as the UK discovered in the 1970s, it can be difficult to control inflation through incomes policies, especially if the unions are powerful.

Monetarism.

Monetarism seeks to control inflation through controlling the money supply. Monetarists believe there is a strong link between the money supply and inflation. If you can control the growth of the money supply, then you should be able to bring inflation under control. Monetarists would stress policies such as:

  • higher interest rates (tightening monetary policy)
  • reducing budget deficit (deflationary fiscal policy)
  • Control of money being created by government

However, in practise, the link between money supply and inflation is less strong.

Supply Side Policies

Often inflation is caused by persistent uncompetitiveness and rising costs. Supply side policies may enable the economy to become more competitive and help to moderate inflationary pressures. For example, more flexible labour markets may help reduce inflationary pressure.
However, supply side policies can take a long time, and cannot deal with inflation caused by rising demand.

Ways To Reduce Hyperinflation

In a period of hyperinflation, conventional policies may be unsuitable. Expectations of future inflation may be hard to change.  When people have lost confidence in a currency, it may be necessary to introduce a new currency or use another like the dollar (e.g. Zimbabwe hyperinflation).

Ways to Reduce Cost Push Inflation

Cost push inflation (e.g. rising oil prices can lead to inflation, but, also lower growth. This is the worst of both worlds, and is more difficult to control without leading to lower growth.

17 thoughts on “Methods to Control Inflation

  1. The government can stop inflation by reducing the consumer expenditure component of GDP by increasing taxes or by reducing transfer payments

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