Problems of Controlling Inflation

Readers Question b) Why, with the aid of these policies, the government often fails to achieve its main objectives of a healthy economic growth, full employment, price stability and a surplus on the balance of payments?

Limitations of Monetary Policy in Controlling Inflation

Cost Push Factors

If there is an increase in cost push inflation. For example, if oil prices rose signficantly, it would become difficult to control inflation and keep growth high. If cost push inflation increases, Aggregate Supply shifts to the left causing inflation and lower growth. To reduce inflation the MPC could increase interest rates. This will reduce inflationary pressure but would further reduce Aggregate Demand and economic growth. Here there is a conflict between different objectives

Time Lags

If inflation increases the MPC can increase interest rates. However, there can be a time lag of upto 18 months before higher rates have the effect of reducing demand. Therefore, it might be too late.
Therefore, there is a difficult in predicting future inflation trends.

Other Factors Affecting AD.

Higher interest rates should reduce consumer spending. However, in practice it might not. There are several factors that determine consumer spending, apart from interest rates. For example, if consumer confidence is very high and house prices are rising. Increased interest rates may be insufficient in reducing consumer spending.

• Policies for dealing with economic shocks