Can interest rates control inflation

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Measure content performance. Develop and improve products. List of Partners vendors. EST: Inflation increased 6. Labor Department reported on Nov. Inflation occurs when an economy grows due to increased spending without a concomitant increase in the production of goods and services.

When this happens, prices rise and the currency within the economy is worth less than it was before. When a currency is worth less, its exchange rate weakens when compared to other currencies. However, this depends on whether other countries are inflating less than yours. If they are inflating faster than your country, your currency might strengthen, which is a basic purchasing power parity argument.

There are many methods used to control inflation; some work well, while others may have damaging effects. It was felt that by keeping the value of the pound high, it would help reduce inflationary pressures. The policy did reduce inflation but at the cost of a recession. See: ERM crisis Wage growth is a key factor in determining inflation. If wages increase quickly, it will cause high inflation.

However, it was effectively dropped because it was difficult to enforce widely. See Price and incomes policies. Targeting Money Supply Monetarism In the early s, the UK adopted a form of monetarism, where the government sought to control inflation by controlling the money supply. To control the money supply, the government adopted higher interest rates and reduced budget deficit.

It did bring inflation down but at the expense of a deep recession. Monetarism was effectively abandoned because the link between money supply and inflation was weaker than expected. See: UK economy This was because:. In these cases of cost-push inflation, it is harder to reduce inflation, and it is maybe better to let the temporary inflation factors come to an end.

Inflation is needed in South Africa to help people learn how to tighten their belts by saving more often and persevering goods that are healthy to the people, walking instead of driving and eating at home instead of restaurant, and investing more time on increasing foreign interest rates by investing ideas and team building activities that will generate an influx in the economy such as hosting a international sport event and encouraging business man and women to boast the economy by being more resourceful and spending less yet gaining net profits , using technological means sparingly and using supplementary methods to better the economy and to also educate more and employ more youth development facilities without wasting money and making means to secure safety for foreigners.

If this is done it can reduce the quality standards of living And a reduction in the GDP of the economy in a long run. What the country needs is to subsidize firms that produce merit goods, which are goods that bring benefits to consumers and third parties to reduce thier cost of production therfore reducing price. And aid the society with the provision of information on the true value that must be placed in merit goods. Which is supposed to be high. This has been a very simplified and better article especially for the beginners to read and understand..

Summary of policies to reduce inflation Monetary policy — Higher interest rates. This increases the cost of borrowing and discourages spending. This leads to lower economic growth and lower inflation. Video on reducing inflation Policies to reduce inflation in more details 1.

Higher interest rates reduce consumer spending because: Increased interest rates increase the cost of borrowing, discouraging consumers from borrowing and spending. Increased interest rates make it more attractive to save money Increased interest rates reduce the disposable income of those with mortgages.

Higher interest rates increased the value of the exchange rate leading to lower exports and more imports. Monetary policy can have some limitations It is difficult to deal with cost-push inflation inflation and low growth at the same time There are time lags. It can take up to 18 months for higher interest rates to have an effect on reducing demand. If confidence is high, business and consumers may continue to spend — despite higher interest rates.

Supply-Side Policies Supply-side policies aim to increase long term competitiveness and productivity. However, supply-side policies work very much in the long term; they cannot be used to reduce sudden increases in the inflation rate. Also, there is no guarantee government supply-side policies will be successful in reducing inflation More details at Supply-side policies 3. Fiscal Policy This is another demand-side policy, similar in effect to monetary policy.

Fiscal policy can reduce government borrowing but is likely to be politically costly as the public dislike higher taxes and cuts to government spending. This makes it a limited policy. Exchange rate policy Sterling exchange rate index, which shows value of Sterling against basket of currencies. A stronger Pound makes imports cheaper lower cost-push inflation Stronger Pound reduces domestic demand, leading to less demand-pull inflation.

A stronger Pound creates incentives for firms to cut costs in order to remain competitive. Incomes Policies Wage growth is a key factor in determining inflation. This was because: The inflation was expected to be temporary — caused by rising oil prices, rising tax rates and the impact of devaluation.

Economy in recession. Related Causes of Inflation The link between money supply and inflation Different types of inflation. So much educative, Reply. Those who can seize the opportunity to walk in front of them will succeed in all likelihood Reply. Educative Reply. Great explanation Reply.

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Lastly, inflation is highly influenced by inflation expectations, as well. Some argue that high inflation rates have inertial effects. In this paper Hussain et al develop an open economy macro model for a small underdeveloped economy, by incorporating both interest rate and exchange rate supply side effects.

They also include inflation, risk premium and exchange rate expectations. These are ways of controlling inflation in the medium term i. A reduction in company taxes to encourage greater investment ii. A reduction in taxes which increases risk-taking and incentives to work — a cut in income taxes can be considered both a fiscal and a supply-side policy iii.

Policies to open a market to more competition to increase supply and lower prices Rising productivity will cause an outward shift of aggregate supply Direct controls - a government might choose to introduce direct controls on some prices and wages Public sector pay awards — the annual increase in government sector pay might be tightly controlled or even froze this means a real wage decrease.

The prices of some utilities such as water bills are subject to regulatory control — if the price capping regime changes, this can have a short-term effect on the rate of inflation Evaluation points — how best can inflation be controlled?