Essay
By Pharm Ike Chinedu Klinsmann
INFLATION is the increase in the price of goods and services in an economy. It translates to reducing the purchasing power of a currency. Measured by the Consumer Price Index (CPI)
Causes of Inflation
1. Growing Economy and Money Supply: When the money supply increases, liquidity rises, people’s purchasing power grows, and therefore, they’re willing to spend on necessities and luxuries. The increased demand for goods and services allows suppliers to raise prices.
2. Disruption in Supply: When there is increased demand, the supply chain is negatively affected due to various factors. For example, during the pandemic, the supply of many goods was disrupted as customers were unwilling to spend much. When there is a demand-supply parity, the prices of goods and services increase as there is a shortage.
3. Poor Government Policies: The government must take specific measures to restrain the demand to a certain level. Inefficient decisions like not adjusting the interest rates in line with inflation every year, not managing the money supply within the country, among others, all lead to the inflation rate rising beyond control.
There are two indices that are used to measure inflation — the consumer price index (CPI) and the wholesale price index (WPI).
How Inflation can be reduced
1. Monetary Policies
One significant monetary way to curb Inflation is to control the money supply in the economy. If the money supply goes down, the demand for goods will reduce, causing a price fall. Another way to curb the money supply is when the government withdraws specific paper notes or coins from circulation. Lowering the lending rate for commercial banks allows money circulation to be controlled.
2. Fiscal Policies
The two essential components of a fiscal policy are government revenue and expenditure. The government can change its tax rates to increase revenue or efficiently manage expenditure. An inflationary gap is created when the demand is higher than the supply. The government can tackle this in two ways.
One, by decreasing the overall government expenditure and transfer payments. Two, increasing the tax rates leads to decreased individual demand and a drop in the economy’s money supply.
3. Deregulation of energy, housing and other markets would reduce the regulatory burden on businesses, lowering the cost of domestic production and bringing down prices.
4. Removing barriers to international supply by reducing tariffs and eliminating regulatory barriers would provide consumers access to cheaper goods and increase the resiliency of supply chains.
Who has the responsibility to Prevent Inflation?
It is the responsibility of a nation’s central bank to prevent inflation through monetary policy. Monetary policy primarily involves changing interest rates to control inflation. Governments through fiscal policy, however, can assist in fighting inflation.
The Bottom Line
Governments have relatively few ways to stop inflation. They can put a cap on prices, but the broad price controls required to impact inflation don’t have a great track record. Pursuing a contractionary monetary policy is the preferred method of controlling inflation today, but so-called soft landings are hard to pull off.
Pharm Ikeagwuonwu Chinedu Klinsmann
Writes from Stockholm, Sweden
19th Feb, 2024
C.E.
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