Skillsfirst Level 3 Certificate in Introduction to Financial Trading (RQF) - UNIT 1: Principles of financial trading
Skillsfirst Level 3 Certificate in Introduction to Financial Trading (RQF) - UNIT 2: Principles of Financial Planning and Cash Flow in Financial Trading
Skillsfirst Level 3 Certificate in Introduction to Financial Trading (RQF) - UNIT 3: Understanding financial trading techniques

STOPPING INFLATION

There are a number of methods which have been suggested to stop inflation. Central Banks such as the U.S. Federal Reserve can affect inflation to a significant extent through setting interest rates and through other operations (i.e., using monetary policy). High interest rates (and slow growth of the money supply) are the traditional way that Central Banks fight inflation, using unemployment and the decline of production to prevent price increases.

However, Central Banks view the means of controlling the inflation differently. For instance, some follow a symmetrical inflation target while others only control inflation when it gets too high. The European Central Bank has come under some criticism for following the later practice, especially in the face of high unemployment.

Monetarists emphasize increasing interest rates by reducing the money supply through monetary policy to fight inflation. Keynesians emphasize reducing demand in general, often through fiscal policy, using increased taxation or reduced government spending to reduce demand. They also note the role of monetary policy, particularly for inflation in basic commodities from the work of Robert Solow. Supply-side economists advocate fighting inflation by fixing the exchange rate between the currency and some stable reference currency such as gold, or by reducing marginal tax rates in a floating currency regime to encourage capital formation. All of these policies are achieved in practice through a process of open market operations.

Another method attempted is simply instituting wage and price controls (see “incomes policies”). For example, they were tried in the United States in the early 1970s under President Nixon. One of the main problems with these controls was that they were used at the same time as demand- side stimulus was applied, so that supply-side limits (the controls, potential output) were in conflict with demand growth.

In general, most economists regard price controls as counterproductive in that they tend to distort the functioning of the economy because they encourage shortages, decreases in the quality of products, etc. However, this cost may be “worth it” if it avoids a serious recession, which can have even greater costs, or in the case of fighting war-time inflation.

In fact, controls may complement a recession as a way to fight inflation: the controls make the recession more efficient as a way to fight inflation (reducing the need to increase unemployment), while the recession prevents the kinds of distortions that controls cause when demand is high.

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