Policies To Tackle Inflation
- Demand pull inflation is best addressed using contractionary demand side policies
- Contractionary fiscal policy & contractionary monetary policy aim to reduce total (aggregate) demand in an economy
- If total demand for goods/services decrease there will be a fall in the general price level thereby reducing the level of inflation
- Total demand can be decreased through any policy which decreases one of the components of real gross domestic product (rGDP)
Examples of Demand-side Policies Which Are Likely To Reduce Demand Pull Inflation
Broad Policy Type |
Specific Policy |
Explanation |
|
Contractionary Fiscal Policy |
Government increases corporation tax |
Firms pay more tax → firms have less profit → firms invest less → rGDP falls → inflation decreases |
|
Contractionary Fiscal Policy |
Government decreases expenditure on national defence |
Government spending decreases → defence firms receive fewer orders from the government → national output falls → inflation decreases |
|
Contractionary Fiscal Policy |
Government increases personal income tax |
Households have less discretionary income → consumption decreases → national output falls → inflation decreases |
|
Contractionary Monetary Policy |
The Central Bank increases interest rates |
Household repayments on existing loans rise → households have less discretionary income → consumption decreases → national output falls → inflation decreases |
|
Contractionary Monetary Policy |
The Central Bank decreases the money supply by stopping quantitative easing |
Firms receive less money from the sale of bonds → investment decreases → national output falls → inflation decreases |
- Demand-side policies are more effective in the short term at dealing with inflation caused by a rise in total (aggregate) demand
- They are less effective at dealing with cost push inflation
- One conflict caused by contractionary policy is that reducing demand pull inflation also reduces output & employment
Examples of Supply-side Policies Which Are Likely To Reduce Cost Push Inflation
Specific Supply-side Policy |
Explanation |
|
The Government reduces regulation on the oil & banking industries |
Regulations removed → costs of production decrease as firms no longer need to spend money meeting requirements → national output (total supply) rises → inflation reduces |
|
The Government changes migration policies to allow more workers into the country |
More workers move into the country → the price of labour (wages) falls → costs of production reduce for firms → national output (total supply) rises → inflation reduces |
|
The Government builds a new rail network serving ports & airports |
Speed & capacity of transport infrastructure is improved → costs of production decrease as firms benefit from the improvements → national output (total supply) rises → inflation reduces |
- Supply-side policy tends to be long term, but highly effective in reducing price levels
- They do not help deal with inflation caused by demand side issues
