Policies to Control Inflation

Policies to Control Inflation

Coast-Push Inflation

• If a government believes that inflation is caused by excessive wage rises, then it may seek to implement measures which halt wage rises
  • In the public sector, it can simply do this by decreasing the amount of government spending allocated to public workers’ pay.
  • For the private sector, the government can implement policies that directly relate to wage increases
    • However, this can create inflexibility in the labour market, as new companies cannot attract workers with higher wages.
  • A government may also reduce corporation tax or subsidise firms
    • This not only stimulates investment, but also means firms can cover rising costs without putting their prices up.
    • However, it could also mean that firms get reliant upon the subsidies, and do not strive to keep their costs down.

Demand-Pull Inflation

• To reduce demand-pull inflation, a government may use deflationary fiscal and/or monetary policy
• These measures will reduce aggregate demand, and hence the price level
  • A government could achieve this by raising income tax, which would reduce people’s ability to spend
  • AD could also be reduced by raising the interest rate, as this will reduce consumption, investment and net exports.

Inflation Targeting

• Inflation targeting can lower the chance of both demand-pull and cost-push inflation by reducing the expectations of inflation
• Inflation is caused by how people act, and so if people have confidence that the central bank can meet their target of inflation, they will act in a way that does not cause inflation

• In the long run, a government would seek to reduce inflationary pressure by increasing aggregate supply
  • If AD increases – a move that would normally increase the price level – but AS increase in line with it, then the price level will remain unchanged
    • This results in the fact that consumers would be able to enjoy more goods and services without inflation and/or balance of payments problems
  • This increase of AS is likely to be the result of successful supply-side policies, as they’re more of a long-run approach to controlling inflationary pressure.
    • Long-run SSP do not have adverse short-term effects on employment and output that deflationary fiscal and monetary policies may.