Controlling Inflation

how inflation is controlled

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Controlling Inflation forms a significant part of the economic activities of a nation. Inflation is an economic condition characterized by a general rise in the prices. Thus, controlling Inflation is important as unrestrained increase of the prices may culminate in Hyperinflation, and an excessive fall in the prices may lead to Deflation. Both the situations are not healthy and sound for the overall growth and development of a country's economy.

In fact, keeping a strong control over Inflation has turned out to be one of the primary objectives of the governments of different countries across the globe. To this effect, efficacious economic policies are being formulated, which mainly concentrate on the fundamental causes of Inflation in an economy, and try to improvise methods to keep the inflationary conditions under control.

For instance, if the primary reason for inflation in a nation is the excessive demand for goods and services, then the economic policy on governmental level should find out the causes of such unnecessary rise and undertake measures to decrease the overall level of collective demand. Sometimes, if it is seen that Cost-Push Inflation is responsible for the rise in the demand for goods and services, then the cost of production must be checked, to handle the inflation-related problems.

Mentioned below are some methods, which have proved to be highly effective in controlling inflation to large extents:

Fiscal Policies:

Fiscal policies are effective in increasing the leakage rates from the circular income flow, thereby rejecting all further additions into this particular flow of income. This brings about a reduction in the Demand-Pull Inflation, in terms of increasing unemployment and slackening the economic growths. Following are a few types of fiscal policies commonly employed:

  • Lowering the expenses on governmental level
  • A fall in the borrowing amounts in the government sectors, on an annual basis
  • High direct taxes, for reducing the disposable income
Monetary Policies:

Monetary Policies have a great role to play in controlling Inflation. These are policies which can actually control the rise in demand, by increasing the rates of interest and reducing the supply of real money. An escalation in the interest rates brings about a reduction in collective demands, in the following three ways:

  • A rise in the interest rate discourages borrowing from both companies

    and households. When interest rates increase, it simultaneously encourages the savings rate, owing to an escalation in the opportunity cost of expenditure.

  • Rise in the interest rates is a very useful tool for restricting monetary inflation. Increase in the real rates of interest decreases the demand for loans, thereby limiting the growth of broad money.
  • There may also be a fall in the commercial investments, due to a rise in the costs of borrowing money. This exerts a direct influence on a handful of planned investment-related projects, which turn out to be unprofitable. This leads to a fall in the collective demand.
  • An increase in the payment of mortgage interests automatically decreases the real 'effective' disposable income of the house owners, as well as their spending capacities. Escalation in the mortgage costs also decreases the demand generated in the housing markets.
  • Exchange Rates:

    An escalation in the exchange rate is possible by increasing the rates of interest or buying money through the central bank interferences in the foreign exchange markets. Mentioned below, is a short-term mean by which inflation can be controlled through exchange rates:

    • Income policies or direct wage controls: Setting restrictions on the growth rate of wages may decrease cost push inflation. On governmental level, an attempt to influence the growth of wage leads to limit the rise in the pay in public sectors, as well as initiates cash restrictions for making payments to the employees of public sectors.

    As far as the private sector is concerned, the government attempts to convince the commercial firms and its employees to implement self-controls at the time of negotiating wages. Generally, there is a fall in the wage inflation when there is an economic depression, leading to a rise in the unemployment rates.

    The long-term means of controlling Inflation are as follows:

    • Supply-side Reform Policy: According to this policy, if more output is produced at a low per unit cost, there are chances for the economy to attain persistent economic growth and development, without being affected by inflation.
  • Policy regarding labor market reforms: If an increase in the flexibility of the labor market permits the commercial firms to put a check on labor costs, it can lead to a reduction in the pressures created by Cost-Push Inflation.
  • Source:

    Category: Bank

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