Government strategies to control inflation
When private spending is more, the government reduces its expenditure to control inflation.
What is inflation
They consider this situation adverse for carrying out their business activities. The Growing Consensus for Inflation Reduction An important reason why so many countries have reduced their inflation rates in recent years is that there has been a growing consensus, particularly among central bankers and even in the public at large, that inflation reduction and price stability should be the primary or overriding long-term goal of monetary policy. Lucas's challenge to policy evaluation using econometric models was based on a simple principle of rational-expectations theory: The way in which expectations are formed the relationship of expectations to past information changes when the behaviour of forecasted variables changes. Although McCallum's analysis is correct as far as it goes, it suggests that the time-inconsistency problem is just shifted back one step: even if the central bank recognises the problem, there still will be pressures on the central bank to pursue overly expansionary monetary policy, with the result that expectations of overly expansionary monetary policy are still likely. As is emphasised in Bernanke and Mishkin and Mishkin and Posen , the calculation of target ranges is a very public exercise. Introduction In the past fifteen years, an extraordinary development has occurred in economies throughout the world: inflation has fallen dramatically in many industrialised as well as emerging-market countries, to the point where many of them have reached what might arguably be called price stability. Supply Side Policies Often inflation is caused by persistent uncompetitiveness and rising costs. As a result, commercial banks need to keep a large amount of cash as reserve from their total deposits with the central bank. Deflationary monetary policy: It involves rising of interest rates and reducing money supply. In such a case, the basic inflationary pressure in the economy is not exhibited in the form of rise in prices for a short time. Higher rates make borrowing more expensive and saving more attractive. The governments in Britain, Spain, Italy and Sweden were unwilling to defend their currencies at all costs and so devalued their currencies.
The Central bank could increase interest rates. Then with estimates of potential output growth and velocity trends, a quantity-equation framework is used to generate the desired monetary growth rate.
Indeed, as the performance of the United Kingdom after the September foreign-exchange crisis illustrates, an industrialised country that has its currency depreciate after a successful speculative attack may do quite well. As part of monetary policy, the central bank might also Introduce a lower inflation target: Many countries have an inflation target e.
In contrast, the typical fixed or pegged exchange-rate regime does allow the monetary authorities some discretion in their conduct of monetary policy because they can still adjust interest rates or conduct open-market operations which affect domestic credit.
This could happen for example when unit wage costs have increased i. This makes the borrowing of money expensive for general public. If there is velocity instability, so that the relationship between the monetary aggregate and the goal variable such as inflation is weak, then monetary-aggregate targeting will not work.
The time-inconsistency problem. A rise in expected inflation after a successful speculative attack against the currency of an emerging-market country can also exacerbate the financial crisis because it leads to a sharp rise in interest rates.
Ways of solving inflation
Monetary policy is one of the most commonly used measures taken by the government to control inflation. Indeed, if anything, the scatter plot in Figure 2 seems to suggest a slight tendency for unemployment and inflation to be positively correlated over the long run. Increased interest rates will help reduce the growth of aggregate demand in the economy. In the case of monetary policy, this may lead policy-makers to try to solve a problem such as too high unemployment using expansionary monetary policy, but by the time the expansionary policy is effective because of long lags, self-correcting mechanisms may have already returned the economy to full employment. As a result, an exchange-rate peg can help lower inflation expectations quickly to those of the targeted country Bruno However, the more the parent gives in, the more demanding a child becomes. List of Conference Participants 1. However, because their decisions about wages and prices reflect expectations about policy, workers and firms will not be fooled by the policy-makers' expansionary monetary policy and so will raise not only their expectations of inflation but also wages and prices. Monetary Policy In a situation of high inflation, monetary policy can have a key role to play. A stronger Pound creates incentives for firms to cut costs in order to remain competitive. If price stability does not persist, that is, inflation occurs, there are several economic costs to the society.
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