Governments and central banks would have to undertake a tight monetary and fiscal policy to combat demand pull inflation. Increasing the interest rate, reducing government spending, or boosting taxes are all examples. Consumers would spend less on durable goods and homes if the interest rate were to rise. It would also raise corporations’ and businesses’ investment spending. Because Aggregate Demand D is rising too quickly in demand pull inflation, these contractionary actions would slow the rise, implying that inflation would still occur but at a slower rate.
How can we avoid demand-pull inflation?
Governments tighten their monetary policy to combat inflation by raising interest rates and reducing government spending. In the United States, the Federal Reserve boosts interest rates during periods of strong economic growth to avoid demand-pull inflation.
How can fiscal policy regulate demand-pull inflation?
2. Policies that affect the supply of goods and services
Long-term competitiveness and productivity are the goals of supply-side policy. Privatization and deregulation, for example, were believed to increase business productivity and competitiveness. As a result, supply-side policies can assist lessen inflationary pressures in the long run.
- Supply-side strategies, on the other hand, are only effective in the long run; they cannot be used to combat abrupt surges in inflation. Furthermore, there is no certainty that government supply-side initiatives will reduce inflation. More information can be found at Supply-side policies.
3. Budgetary Policy
This is a demand-side policy that works similarly to monetary policy. Fiscal policy entails the government altering tax and expenditure levels in attempt to impact Aggregate Demand levels. To combat inflationary pressures, the government can raise taxes and cut spending. This will lessen the effects of Alzheimer’s disease.
- Fiscal policy can help the government borrow less money, but it is likely to be politically costly because the public dislikes higher taxes and spending cuts. As a result, it is a restricted policy.
4. Foreign exchange strategy
The UK joined the ERM in the late 1980s as a way to keep inflation under control. It was thought that by maintaining the value of the pound high, inflationary pressures would be reduced.
- Domestic demand is reduced by a stronger pound, resulting in lower demand-pull inflation.
- A stronger Pound encourages businesses to reduce expenses in order to stay competitive.
Although the program reduced inflation, it did so at the expense of a recession. The government had to raise interest rates to 15% to keep the value of the pound against the DM, which contributed to the recession.
5. Policies on Incomes
Inflation is mostly determined by wage increases. Inflation will be high if salaries expand quickly. There was a brief attempt in the 1970s to curb pay rise using wage controls known as “Price and Incomes programs.” However, because it was difficult to implement generally, it was virtually dropped. Price and income policies can be found here.
6. Money Supply Targeting (Monetarism) The United Kingdom embraced a type of monetarism in the early 1980s, in which the government attempted to manage inflation through controlling the money supply. To keep the money supply under control, the government raised interest rates and lowered the budget deficit. It did reduce inflation, but at the cost of a severe recession. Because the link between money supply and inflation was weaker than projected, monetary policy was practically abandoned. See the UK economy from 1979 to 1984.
Difficult types of inflation to control
The UK suffered cost-push inflation of 5% between 2008 and 2011/12, which was more than the aim of CPI = 2%. The Bank of England, on the other hand, did not change its monetary policy. This was due to the following:
- Rising oil costs, rising tax rates, and the impact of devaluation were projected to generate temporary inflation.
- The economy is in a downturn. The Bank of England did not want to diminish aggregate demand while the economy was in recession because it believed it was more vital to support economic growth.
It is more difficult to reduce inflation in these cases of cost-push inflation, and it may be better to let the temporary inflation factors fade away.
How can cost-push and demand-pull inflation be managed?
This would involve raising interest rates, which is the same as combating cost-push inflation because it reduces demand, reducing government expenditure, and raising taxes, all of which diminish demand.
How can inflation be kept under control?
Inflation can be managed via a contractionary monetary policy, which is a frequent means of doing so. By lowering bond prices and raising interest rates, a contractionary policy tries to reduce the quantity of money in an economy. As a result, consumption drops, prices drop, and inflation decreases.
How does demand-pull inflation work?
The rising pressure on prices that accompanies a supply shortage, which economists define as “too many dollars chasing too few things,” is known as demand-pull inflation.
How do you deal with inflationary cost pull?
Reduced production costs are the best way to combat cost-push inflation. A supply-side policy is a good idea, but it will take a long time to take effect. Wage subsidies are something that the government can do. The government assists firms in this scenario by covering a percentage of labor costs.
What factors are responsible for demand-pull inflation?
Demand-Pull Inflation Has Six Causes
- Inflationary Expectations Ben Bernanke, the former Chairman of the Federal Reserve, put it this way:
Which of the following scenarios represents demand-pull inflation?
Consumers have more money to buy televisions, thus the prices of televisions and their parts are rising as a result of demand-pull inflation.
What makes demand-pull inflation beneficial?
I’d be tempted to walk into a meeting and say if I were the ECB’s cleaner.
Many economists would be hesitant to term it “healthy inflation,” and they would still be concerned about the costs of inflation.
In most cases, increased aggregate demand causes inflation (demand-pull inflation). Inflation is a sign that the economy is getting close to full employment. The economy is booming, unemployment is low, and the government is raking in record-high tax receipts, which is helping to cut the budget deficit. Although inflation has significant drawbacks, it does result in lower unemployment.
This inflation is beneficial because policymakers believe they have the ability to lower it. For example, if the MPC believes the economy is developing too quickly and demand-pull inflation is rising too quickly, interest rates could be raised to reduce inflation. There may be delays, and it may be impossible to forecast when interest rates will be raised. However, authorities are used to dealing with this type of inflation. They have an inflation objective to meet, and it is their responsibility to do so.
The issue is that policymakers currently feel powerless. Although inflation is over their objective, they are unable to raise interest rates due to the economy’s slump and high unemployment (albeit the ECB did hike rates in 2011, but that’s another story). As a result, the MPC is forced to write a slew of letters to the chancellor, explaining that the current inflation is only temporary and does not represent underlying inflationary pressures. They make a reasonable point, but policymakers aren’t looking so powerful after years of explaining away ‘temporary inflation.’