Effects of Bringing up Interest Rates on Inflation

What causes inflation? How is inflation harmful to the economy? How can raising interest rate lower inflation? (1000)

Introduction

Inflation is thought as continuing surge in the general level of prices, so that it costs more to buy a typical package of goods and services that is produced or consumed or both. In simple words, inflation leads to a decline in the real value of money. Sloman (2006) explains that the speed of inflation steps the annual percentage upsurge in prices. Consumer Price Index (CPI), which is released every month, can be used to measure the rate of change in consumer prices.

Undoubtedly, inflation can be an undesirable condition for an economy. Prior to discussing the results of inflation throughout the market, it is important to understand the sources of inflation. Inflation may be induced by demand area factors or source aspect factors.

As it could be seen from the above diagram in the case of demand draw inflation the AD curve shifts to the right because of an increase in demand which causes a rise in outcome. Thus it is associated with a flourishing overall economy. The suppliers is only going to be willing to provide more at an increased price therefore raise the degree of price. Whilst in the case of cost force inflation, there is an increase in price because of this in an increase in the price tag on production independent of aggregate demand. This may occur consequently of increase in wages, or it could be that import price has increased regardless of an increase in demand. There might be an increase in the level of fees as well. Therefore any factor which plays a part in an increase in the cost of production which contributes to a rise in inflation causes cost drive inflation. Due to which there's a move in the AS curve left. The suppliers will not bear the increased expense of production and instead will transfer the purchase price to the consumers by increasing prices and therefore fuelling inflation.

Amongst several unsafe effects highlighted Gwartney et. al (2000) argued that inflation distorted the info shipped by prices. They further stated that people taken care of immediately high and adjustable rates of inflation by spending less time producing and additional time trying to safeguard themselves from inflation. Furthermore, inflation results increased doubt which reduces the level of investment. A reduced degree of investment would hamper economical development, which further restricts people having a better quality lifestyle and could also lead to unemployment. Further criticisms are that inflation redistributes income from those on set incomes and the ones in a weakened bargaining position to the people who can use their economic capacity to gain large pay, lease or profit boosts. Higher levels of inflation also worsens balance of payments position, a higher rate of inflation makes a country's export less competitive in world market segments and imports become cheaper and more appealing. Besides, extra resources are used to handle the consequences of inflation.

Increasing interest levels has been one of the alternatives offered to battle increasing degree of inflation. Inflation has for long been considered a financial trend and economists believe inflation can best be tackled by adopting the monetary coverage approach. THE UNITED KINGDOM economy recently is a good example of such solution. Inflation was 3. 79% well above the 2% aim for and following the increase in interest rate before weeks to 5. 5% and also an expected increase in interest rate has led the inflation rate to show up to 2. 8% in April (Website: BBC). In the united kingdom Bank of Great britain sets the rates of interest which controls the money supply and subsequently control buttons inflation as well. THE UNITED KINGDOM government employs a focus on and instrument method of keep inflation in order. Increasing interest levels with a view to handling inflation works in a manner that it reduces the amount of money supply. People have an incentive to save lots of alternatively than spend, therefore handling the increasing climb in prices. This solution is a good approach although government should be cautious to not continuously raise interest rates and curb spending since it would then adversely affect aggregate demand therefore slowing economic growth.

Besides interest rates, the government may possibly also choose for fiscal policy procedures by increasing level of fees or may be lowering authorities spending and for the reason that manner controlling supply of money, To deal with cost-push inflation, authorities could provide duty pain relief or provide subsidies to firms so that the price of production reduces which could lead to the makers maintaining the amount of prices somewhat than increasing them. Some economists have also stated that costs of inflation may be gentle if the inflation is maintained in single characters.

Conclusion

From the preceding paragraphs it can be said that increased degree of inflation is not really a appealing situation for an overall economy. However, a certain degree of inflation is required throughout the market to incentivise suppliers to create more and better variety of goods and services. Inflation poses to be always a problem when the level of increased prices dampens exports, reduces the competitiveness of a country and begins affecting the economic growth of the united states by creating uncertainty and therefore leading to reduced degree of investments. However, fiscal and financial policy methods can be taken to regulate the increasing degree of inflation. Increasing interest rates, brings about a restricted circulation of money resource, resulting in reduced degree of spending, keeping more, challenging less of goods and services and therefore leading to a slower increase in prices. Fiscal policy procedures could also be used to overcome inflation. More importantly for an overall economy to grow lowering degrees of inflation is an important macroeconomic goal. In conclusion it could be said inflation can be adversely affect levels of economic development if allowed to walk out palm and increasing rates of interest is undoubtedly one of the ways, though not the only way, to deal with inflation.

BIBLIOGRAPHY

  1. Dornbusch, R. , Fisher, S. , Macroeconomics, (2000), Eighth Release, Mc-Graw Hill Education
  2. Griffiths, A. and Wall structure, S. , Applied Economics, (2001), Ninth model, Foot Prentice Hall
  3. Gwartney, James D. , Stroup, Richard L. , and Sobel, Russell S. , Economics Private and Community Choice, (2000), Ninth Model, The Dryden Press.
  4. Sloman, J. , Necessities of Economics, (2004), Third release, Feet Prentice Hall
  5. Howells, P and Bain, K, The Economics of Money, Bank and Money, (2002), Prentice Hall

Journals and Articles

  1. Carlstrom, Charles. , Money Progress and Inflation: May Fiscal Policy matter?, Federal Reserve Bank of Cleveland, April 15, 1999

Internet and also other Sources:

http://media. bbc. co. uk/1/hi/business/6656899. stm

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