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Inflation Control

December 6th, 2009

Inflation Control Controlling inflation is one of the most important objectives of government economic policy in many countries. Effective policies to control inflation focus on the causes of inflation in the economy. Monetary policy controls the growth of demand by creating an increase in interest rates and a reduction in the real money supply.

Higher interest rates reduce aggregate demand in three main ways:

• Discouraging borrowing by both households and organizations.

• Increasing the rate of saving. Thus people will save more and spend less. Thus money in the market will be less

• The rise in mortgage interest payments will reduce homeowners’ real ‘effective’ disposable income and their ability to spend. Increased mortgage costs will also reduce market demand in the housing market

• As the cost of borrowing will increase business investment may also decrease.

The government generally alters the fiscal policy to fight inflation:
• It increases the direct taxes thus causing a fall in disposable income
It lowers spending which decreases demand

Exchange rate appreciation:
An appreciation in the currency makes exports more expensive and reduces the volume of exports and boosts supply thereby reducing aggregate demand. It also demands firms to keep costs down to remain competitive in the world market. A stronger currencies reduces import prices. This makes raw materials and components cheaper.

Labour market reforms:
The weakening of trade union strength, the growth of part-time and temporary workforce along with the concept of flexible working hours have increased flexibility in the job market. This helps get maximum productivity out of individuals and companies.

Supply-side reforms:
Supply side reforms seek to increase the productivity of the economy in the long run and raise the rate of growth of capital productivity. Productivity helps to control unit costs and eases pressure on producers to raise their prices.

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