A country's government would take a number of steps to control inflation. The first thing anybody would consider when it comes to inflation are the causes of inflation in the first place. Is it rising because of very high production costs (cost-push inflation) or is because of the highly increasing demand for a product in the market (demand-pull inflation)? Then, it can take steps to control the cost of production as in the former case and reduce demand or increase supply in the latter case. This is, of course, no simple exercise. The government therefore has a number of policies that would affect the way producers and consumers respond. These policies, when implemented, eventually control inflation. There are two types of policies for this purpose:
Other ways to control inflation are:
- Monetary Policy: The monetary policy is used by a country's federal (central) bank. It manipulates the amount of money in the market by fixing reserve ratios (which inevitably affect the lending capacity of the commercial banks). Central banks can also increase interest rates on the loans so that less people are able to buy securities. This reduces the growth of 'free' or broad money.
- Fiscal Policy: This is more commonly used for controlling demand-pull inflation. Using this policy, the government might cut down on government spending, and increase direct taxes. Thus, growth decreases (as less amount is available for investment because of the high taxes) and unemployment eventually lead to a cut in the public's buying capacity which in turn, reduces demand.
Other ways to control inflation are:
- Fixing the exchange rate
- Income policies that set limits on the rate at which wages can grow. These are also known as Direct Wage Controls.
- Labour Market Reforms
- Supply side reforms (that aim at increasing production at lower cost)