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How Do Governments Deal With Inflation?

It's interesting that all plans or solutions that don't address the root cause only make things worse if and when they are used. In this article, I will explain different policies which can be used to cope with inflation and how do they work.

Representational Image
Representational Image

Inflation happens when the demand for products and services exceeds the supply of those goods and services. Prices might rise because of supply restrictions that raise the cost of manufacturing products and services, or because customers, enjoying the advantages of a thriving economy, spend their extra income faster than producers can boost output. Most of the time, a mix of these two things leads to inflation.

Everyone says he doesn't like inflation, but what do we see? Almost everyone is ignoring the only solution and instead coming up with plans to lessen the bad effects of inflation.

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It's interesting that all plans or solutions that don't address the root cause only make things worse if and when they are used. In this article, I will explain different policies which can be used to cope with inflation and how do they work.

Here are some policies Governments use to deal with inflation.
1.  Monetary Policy
Higher  interest rates diminish demand in the economy, resulting in weaker economic growth and lower inflation, which is the goal of monetary policy. According to monetarists, limiting the money supply may help reduce inflation since the money supply and inflation are closely linked.
The economy's ability to fulfil demand may not be able to keep pace with rising demand during times of higher development. When companies raise prices to make up for shortages, this adds to inflationary pressures. This is called demand-pull inflation. So, if the growth of aggregate demand (AD) slows down, inflationary pressures should go down.

Interest rates could go up if the Central Bank decided to. An increase in interest rates increases the appeal of saving over borrowing. This should cause consumer spending and investment growth to slow down. It result in decrease of inflationary pressure via the following means:

  •  Lowering the price of imports. (less expensive imported goods
  • Bringing down the need for exports.
  • Getting exporters to reduce prices more often.

2.  Goal for inflation:
Many nations use an inflation goal as part of their monetary policy. People's inflation expectations will be reduced if they feel the inflation goal is credible, according to this concept. Countries have also given the Central Bank the freedom to decide on monetary policy on its own. To put it another way, it's argued that an unbiased Central Bank would be able to determine interest rates without political interference.
3.  Fiscal Policy
It is possible to decrease expenditure, demand, and inflationary pressures by raising the rate of income tax. Government finances improve and demand in the economy is reduced as a result of this policy.
By lowering the rise of aggregate demand, these strategies decrease inflation. Reducing inflationary pressures by slowing the rise of AD may be done without generating recessions if the economy is growing quickly.
4.  Wage Control:
A theoretical benefit of wage limits is that they might minimize inflationary pressures. But, other than the 1970s, it hasn't been used much.
The slowing of pay growth may be an effective way to control inflation if it is the root reason (e.g. strong unions negotiating for higher real wages). Cost-push inflation is lessened by slower wage growth, and demand-pull inflation is kept in check.
5.  Policy on the supply side
Most of the time, inflation is caused mainly by businesses not being able to compete and costs going up. Supply-side strategies, however, might take a long time to implement and are unable to control inflation due to an increase in demand.
6.  Cost-Push Inflation:
Increases in the cost of goods and services (such as the price of oil) may cause inflation and slow development. To regulate without slowing down economic development would be tough in this situation because of the worst of all worlds.
7.  Rate Discount
When the Federal Reserve lends money to private banks and other financial institutions, it charges an interest rate called the discount rate. Those who make these short-term loans do so via a mechanism known as the discount window. Fed Board of Governors and each regional bank's board of directors decide the discount rate, which is the same across Reserve Banks, by unanimous consent.
Even while the primary goal of the discount window is to meet banks' short-term liquidity requirements and keep the financial system stable, the discount rate is just another interest rate that must be increased in order to curb inflation.

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There are not many ways for governments to stop inflation. Although they can put a price limit in place, they don't have a strong track record when it comes to wide pricing regulations. Today, the best way to control inflation is with a monetary policy that makes money tighter, but "soft landings" are hard to pull off.
How are prices kept from going up too much?
It is common for the Federal Reserve to boost interest rates when inflation is out of control in order to slow the economy and bring inflation under control.
How can a business prevent inflation?
Take out a loan to reinvest in your company's future success. Getting a business loan might assist if you're struggling to meet client demand and need more operating cash.
4.    Decide on a pricing increase for your company.
5.    Spend less on your business.
6.    Spend your money on business technology.

Disclaimer : The above is a sponsored post, the views expressed are those of the sponsor/author and do not represent the stand and views of Outlook editorial.