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Government Policy Options for Dealing with Inflation


Discuss the policy options available to a government faced with inflation, and consider which is most likely to be effective. [12]


Macroeconomic Factors and Policies

[CIE AS level November 2016]

Preview Answer

Step ➊ : Define ‘inflation’ in the introduction.

Inflation occurs when there is a sustained increase in the general price level. High inflation rates are considered to be damaging to an economy in several ways. It discourages investment and long term economic growth. It makes an economy uncompetitive. It leads to a fall in the value of money and menu costs. This is why most central banks and governments target low inflation. If inflation rises above this inflation target there are certain economic policies that can be applied. Policies to solve the problem of inflation include fiscal policy, monetary policy and supply-side policies.

Step ➋ : Discuss how fiscal policy can be used to solve inflation and it’s limitations.

➤ 2.2.1 To reduce demand-pull inflation, governments employ deflationary fiscal policy.

Fiscal policy can be used to correct demand-pull inflation. Demand-pull inflation occurs when prices are pulled up by increases in aggregate demand that are not matched by equivalent increases in aggregate supply. Fiscal policy is the means by which a government adjusts its spending levels and tax rates to monitor and influence a nation's economy.

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