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, reducing spending
- Increased interest rates make it more attractive to save money
- Increased interest rates reduce the disposable income of those with mortgages
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2. Supply Side Policies
Supply side policies aim to increase long term competitiveness and productivity. For example, privatisation and deregulation were hope 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
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
12 comments ↓
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?
[...] Comment on post: Economic Policies to reduce inflation [...]
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.
[...] Question From: Economic Policies to Reduce Inflation. What about a case were there is inflation and government needs central bank to print more money to [...]
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good for my economics essay
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
How can Inflation be reduced in Nigeria?
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..
what are the actual causes of unemployment?
But these are mostly the solutions to demand-pull inflation.What about imported and cost-push inflation?
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what are the different anti inflationary measures that can be adopted in a country like nigeria.
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