How does monetary policy affect inflation

how does monetary policy affect inflation

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Businesses and investors with large amounts of money tend to invest in assets to avoid the losses caused by inflation. As the inflation of prices results in an increase in the value of investments, such as real estate or stocks, investors are able to preserve the value of their wealth even as the price of currency falls. Thus, small inflation rates encourage investment while discouraging the hoarding of money. Inflation also decreases the value of bank loans, easing the burden of homeowners and students.


Although inflation can encourage investment, increased investment can lead to speculation and mismanagement of hedge funds and brokerage firms. It also increases the price of exports, causing other countries to look elsewhere for cheaper deals. On the other hand, a devalued currency means that imports become more expensive; the rise in prices of imported goods leads to even higher inflation. Fixed and low-income families generally can't keep up with rising prices, damaging their standard of living.

During the American Revolution, states started to print lots of bills to pay for their wartime debts. As more was printed, the value of these Continentals fell and even more had to be printed to make up the difference. Eventually, Continentals became nearly worthless. The U.S. Constitution prohibited states from printing their own currency to prevent this kind of inflation from reoccurring.

Managing Inflation


enjoy the benefits of inflation without suffering too many ill effects, governments try to maintain a low level of inflation, typically below 5 percent. A government's central banks can help moderate inflation by regulating interest and lending rates. Higher interest rates reduce the money supply and slow inflation. Alternately, governments can fix wages or the costs of goods in order to prevent prices from rapidly rising. Other methods involve manipulating the supply and demands of goods through import and export regulations.


If inflation is allowed to continue unmanaged, it can lead to a state of hyperinflation. Hyperinflation is a period of rapid inflation, causing the cost of goods to double rapidly, sometimes in only a few months. During hyperinflation, a government's currency becomes practically worthless, exports slow down, foreign investment stops, citizens begin to conduct business through more stable currencies or by bartering, and the country's purchasing power is wiped out. Thus, governments are careful to avoid hyperinflation by managing annual inflation rates.

Today's Policies

Inflation rates fell dramatically in 2009, as the global recession led to drops in consumer demands and significantly reduced prices. As nations begin to come out of these recessions, they continue to leave interest rates low to increase inflation rates and reduce the burden of indebted consumers. As these consumers start to spend more, increased demands for goods will help to jump-start national economies by encouraging production rates.


Category: Bank

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