Policies To Reduce Inflation

Readers Question: what are the economic policies that lead to low inflation in an economy?

1. Monetary Policy 

In the UK and US, monetary policy is the most important tool for maintaining low inflation.  In the UK, monetary policy is set by the MPC of the Bank of England. They are given an inflation target by the government. This inflation target is 2%+/-1 and the MPC use interest rates to try and achieve this target.

The first step is for the MPC to try and predict future inflation. They look at various economic statistics and try to decide whether the economy is overheating. If inflation is forecast to increase above the target, the MPC will increase interest rates.

Increased interest rates will help reduce the growth of Aggregate Demand in the economy. The slower growth will then lead to lower inflation. Higher interest rates reduce consumer spending because:

  • Increased interest rates increase the cost of borrowing, discouraging consumers from borrowing and spending.
  • Increased interest rates make it more attractive to save money
  • Increased interest rates reduce the disposable income of those with mortgages.
  • Higher interest rates increased the value of the exchange rate leading to lower exports and more imports.

Diagram Showing Fall in AD to Reduce Inflation

inflation

Base Rates and Inflation

inflation-interest-rates

Base interest rates were increased in the late 1980s / 1990 to try and control the rise in inflation.
See also:

2. Supply Side Policies

Supply side policies aim to increase long term competitiveness and productivity. For example, privatisation and deregulation were hoped to make firms more productive. Therefore, in the long run supply side policies can help reduce inflationary pressures. However, supply side policies work very much in the long term. They cannot be used to reduce sudden increases in the inflation rate. Supply side policies

3. Fiscal Policy 

This is another demand side policy, similar in effect to Monetary Policy. Fiscal policy involves the government changing tax and spending levels in order to influence the level of Aggregate Demand. To reduce inflationary pressures the government can increase tax and reduce government spending. This will reduce AD.

4. Exchange Rate Policy

In the late 1980s the UK joined the ERM, as a means to control inflation. It was felt that by keeping the value of the pound high, it would help reduce inflationary pressures. The policy did reduce inflation, but at the cost of a recession. To maintain the value of the £ against the DM, the government had to increase interest rates to 15%. The UK no longer uses this as an inflationary policy.

5. Wage Control

Wage growth is a key factor in determining inflation. If wages increase quickly it will cause high inflation. In the 1970s, there was a brief attempt at wage controls which tried to limit wage growth. However, it was effectively dropped because it was difficult to widely enforce.

Related

29 Responses to Policies To Reduce Inflation

  1. Sheena Ang February 20, 2008 at 6:38 pm #

    How about the case of cost push inflation like that of China? there’s high inflation and yet the economy is not operating at its full level of employment and due to the fact that its exchange rate is fixed, monetary policies would not be effective but fiscal policies would further increase unemployment. What policies can be implemented to reduce this cost push inflation in a fixed exchange rate system?

  2. samuel chima September 22, 2008 at 5:11 pm #

    what about a case were there is inflation and government needs central bank to print more money to spent and does not want to increase tax or interest rate.what can policies should the central bank adopt on this case.

  3. tyjghguuiy April 6, 2009 at 5:26 pm #

    thanksssssssssssssssssss!!!!!!!!!!!!!!!!!

    good for my economics essay

  4. Md. Alauddin Majumder June 2, 2009 at 7:49 pm #

    In developing economies the prime reasons for inflation are bred in the supply side. Such economies are commonly plagued by supply side factors like market syndication, exploitation by middle-men, extortion, natural calamities, presence of avoidable production costs etc. The demand factors are less prominent by their very nature. This is why the supply side should get due consideration while addressing the problem of inflation

  5. Aminah Ojetola July 28, 2009 at 2:44 pm #

    How can Inflation be reduced in Nigeria?

  6. Andrew gadama October 16, 2009 at 3:31 pm #

    Nigeria should stop access borrowings as this may lead to an increase in prices.The more the gvt borrows the more it increases money suppy.Higher money supply result into access money supply which will lead to high aggregate demand encouraging films to raise prices of their goods and services..Tight fiscal policies and tight monetary policies could also be the solution to inflation..

  7. Andrew gadama October 16, 2009 at 4:01 pm #

    what are the actual causes of unemployment?

  8. Azfar Kashif December 7, 2009 at 12:17 pm #

    But these are mostly the solutions to demand-pull inflation.What about imported and cost-push inflation?

  9. chinwe March 9, 2010 at 4:59 pm #

    what are the different anti inflationary measures that can be adopted in a country like nigeria.

  10. Owusu Bonsu Isaac June 9, 2010 at 2:25 am #

    Controlling inflation is atremendous effort that need to embraced by all.After both types of inflation has been properly been curbed or averted the world economy will experience new face on employement policies and have a new breath on the standard of living around the globe.

  11. Osuji, Uchechukwu June 13, 2010 at 6:52 pm #

    can inflation be reduced or eliminated in Nigeria. why or why not

  12. Sarah Oh June 22, 2010 at 1:57 pm #

    In China, cost-push inflation can be reduced if we can make the people have faith in the central bank. If people do not expect higher inflation, they will not make demands for increases in wages and this will keep the cost of labor from rising.

  13. Samantha October 6, 2010 at 9:51 pm #

    what can lead to failure in measures to tame inflation

  14. Lindokuhle August 17, 2011 at 5:28 pm #

    It easy an undustandable to read an follow what it say.All in all i think u guys you are the best.

  15. Lindokuhle August 17, 2011 at 5:29 pm #

    It perfact

  16. neela September 13, 2011 at 6:38 pm #

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  17. joy martin October 10, 2011 at 7:38 am #

    thanx …………m done with wit my assignment

  18. mash February 6, 2012 at 12:36 pm #

    yeah this good but how i wish more could be added

  19. Makasa Musonda May 24, 2012 at 1:48 am #

    I have like the data that I have found here. Please make a lot of Data like this one more available. The world will have uneconomical mind. In short the world will learn to distribute its resource fairly. Good stuff keep it up.

  20. afolabi July 13, 2012 at 11:32 am #

    in need of how wage rate can control inflation problems

  21. Bimbo temmy August 12, 2012 at 11:47 am #

    Whose monetary theory should u think it should be applied is it dat of classical economic theory or keynes law or that of says law

  22. LISDA ETHEA September 14, 2012 at 4:34 am #

    kk thNKS It was very helpful!!!!!

  23. Reea October 1, 2012 at 4:24 am #

    It is a pleasure and grateful to thanks for this page because it help me understand the types of inflation clearly and help me to completed my I.A at school.

    Thank u a lots and I understand it very well

  24. krestina diana kuumbwa March 24, 2013 at 9:14 pm #

    this information about inflation real help me to complete ma work en teachs me alot. now i can even able to answer quetion about inflation. its more helpful..

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