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How do Governments Deal with Rising Inflation?

During periods of high inflation, there is greater economic uncertainty meaning lower economic growth and less consumer confidence. Often, during times of higher inflation, people will need to borrow more money and people looking to borrow £1,000 online as well as other amounts tends to increase as the squeeze on personal finances increases.

High inflation is not sustainable for the economy in the long-run thus it is the responsibility of governments to try and control inflation. There are many different methods they can use to do this.

Why does inflation occur?

Inflation occurs when an economy experiences increased spending without supply of goods and services increasing, putting a strain on the economy. As a result, prices rise and the purchasing power of a currency decreases.

Simply put, this means that the currency will not be able to buy as much as it could before and goods and services become more unaffordable.

In practice this means that when it comes to loans and finance for consumers, the underwriting process will also have to take into account the fact that applicants are able to afford less, as their money does not go as far as it otherwise would.

What does rising inflation mean for the government?

When there is high inflation, there is increased political pressure. Higher inflation rates means that everyday living becomes more expensive for consumers, with many households struggling to make basic ends meet.

As the cost of living increases, there is more public suffering. Not only does this mean less investment, less spending and lower economic growth, it also relies on more government spending in order to compensate. Already the government is expected to spend £12bn this financial year in order to support UK households through this cost of living crisis.

What can the government do to combat the effects of rising inflation?

There are many different strategies that the government can implement in order to fight inflation, such as via wages or price controls and the UK government for example has been providing support for people struggling with the cost of living and inflation. However, it is a delicate game as they risk causing recession and redundancies.

Here are a few examples of the action that governments can take in order to combat high inflation rates.

  1. Monetary policy

    When interest rates are higher, there is a lower level of demand in the economy. As a result, there is less economic growth and lower inflation. If the government chooses to increase interest rates, borrowing is less appealing as it is more expensive and saving money becomes more attractive. This means there is lower growth due to decreased consumer spending and investment.

    Higher interest rates can help to reduce inflationary pressure due to a higher exchange rate which means that imports are cheaper, there is less demand for exports and there is more incentive for exporters to cut their costs.
  2. Controlling money supply

    The government can control money supply in order to control inflation. Policies such as higher interest rates, reduction of budget deficit or controlling the amount of money being created can all work to control rising inflation rates.
  3. Supply-side policies

    If inflation is due to rising costs and an uncompetitive economy, supply-side policies can be used to make the economy more competitive and increase the efficiency of the economy. This puts a downward pressure on costs in the long-term and can reduce inflationary pressures.
  4. Controlling wages

    Wage controls could be used by the government to reduce inflationary pressures; however, it is rarely used as it is difficult to overcome powerful workers’ unions. This method only really works if the inflation has been caused by wage inflation.
  5. Fiscal policy

    If the government increases the level of income tax, it means that consumers are paying more tax for the same amount of income. This means that their disposable income is less. As a result, spending will decrease and so will consumer demand; subsequently, inflationary pressure will also decrease.

Written by Marcus Richards

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