How does the government try to control inflation

how does the government try to control inflation

Exploration of Government Policies to Achieve the Inflationary Target

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Exploration of Government Policies to Achieve the Inflationary Target

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The aim of this essay is to explain to the reader what is meant by the

term ‘inflation’ and to outline the policies used by the government to

achieve its inflationary target. To help me achieve my aim I am going

to use various resources throughout the essay, this includes slides

provided during lectures, materials received in tutorials and internet

sites with the relevant information for me to complete my aim.

Inflation is the increase in the costs to produce a product. When

these costs rise, the value of money falls, meaning that when there is

inflation our money buys us less. There are many different types of

inflation and examples of these are demand pull inflation and cost

push inflation.

The control over inflation has become one of the government’s main

objectives. There can be lots of different reasons for inflation such

as excess demand for goods and service or cost-push inflation, etc.

To help control this, different policies have been set to help the

government achieve the inflationary target. However it is not that

easy to predict inflation. Many different decisions are made by large

or small businesses every day that could affect inflation such as an

increase in selling price or a change in import or export of goods.

Also a change in inflation abroad can affect the UK if goods are being

The British government has pursued an explicit inflationary target

since 1992. There are advantages and disadvantages of having an

inflationary target. Several economic benefits can be achieved by

having an effective target, such as, if there is a low economic target

then there will be a low inflationary expectation from workers and

thus may encourage them to accept a slower pay rise. Also a constant

low inflation can encourage more capital investment. In August 1999,

a Bank of England report said that (2) “inflation targets have been

successful in reducing inflation expectations and improving people's

understanding of the inflation process.”

A disadvantage of the inflation target is that constant fluctuations

in the exchange rate and increases in inflation rates in other

countries can put the domestic inflation rate higher, this can mean

higher interest rates and thus damaging economic growth.

Over

the last few years the UK inflation has been well below the

target expectation, giving low, stable inflation. We are now going to

look at the policies that the government have been using to help them

control the levels of inflation. The first policy we are going to

look at is the Fiscal Policy.

The fiscal policy includes three main parts. Lower government

spending, reduction in the amount the government borrows every year

and higher direct taxes. This policy try’s to reduce the outgoings

and in goings to the circular flow of income, reducing demand pull

inflation.

Another policy used by the government is the Monetary Policy. In May

1997 the Bank of England was given the independence to set interest

rates in the UK. They had to set these rates with the aim of keeping

inflation under control for the next two years to control the growth

of demand. For example, (3) the interest rates went up to 15% in the

late 1980s. By raising the interest rates the demand fell and

receeded again in the 1990s. By having high interest rates, the

demand is reduced because it discourages people from borrowing money

and increases the rate of saving. Also by raising the mortgage

interest rates it discourages disposal income spending and reduces the

demand in the housing market. If the interest rates rise 1% above or

below the target the Bank of England has to write to the government

explaining why this is.

Long term polices such as Labour market reforms and supply-side

reforms. Labour market reform aims to increase flexibility by

weakening the trade union power and having more flexible working

hours. Supply side reform aims to produce a greater number of goods

at a smaller cost per unit.

Another policy that was used but has not been used since the late

1970s is the income policy. This is direct wage control. Although

the policy is no longer used the government still try’s to influence

wage growth by restricting pay rises.

The key to controlling inflation is to keep control of aggregate

demand but at the same time increase supply. I mentioned that there

has been low, stable inflation over the past few years. Reasons for

this are low wage growth, success of the Bank of England, increased

efficiency, cuts in prices of utilities and lower inflationary

expectations. This shows us that the government’s policies are

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