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Monetary Policy - Inflation - CuresExplanationThe most appropriate cure for inflation depends on what you think the cause is. If a doctor thinks you have flu, then they won't treat you for a sprained ankle. The same should be true for economies. The problem is that doctors often agree far more what is wrong with the patient than economists do about economies! That aside, a considerable amount of research has gone into the causes of inflation, and a much more sophisticated understanding has emerged. So what cures are there? As we have said the cure has to relate to the cause. If you think that inflation is caused by demand growing faster than the economy can cope with (demand-pull inflation), the answer is to try to control the level of demand. If you think inflation is caused by a lack of capacity or by costs rising in the economy, then supply-side solutions may be required. If you think that inflation is caused by excessive monetary growth, then it will be most appropriate to put in place policies to control the level of money supply growth. In practice, all of these will be appropriate to a greater or lesser extent; indeed they are inter-linked and cannot be looked at in isolation. In practice the most emphasis generally goes into looking at the level of demand. Is it growing faster than supply? If so, do we need to slow the economy down a little? What causes changes in demand? How do people react to interest rate changes? Though other factors like the capacity of the economy are very important, policies to affect these are often outside the hands of the Bank of England. The government may have to deal with these. In addition, supply side policies tend to be rather long term in nature whereas demand can be influenced more quickly - in economic terms anyway! For more detail on each of these, why not have a look at the theories section for the cures of inflation. |
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