Governments Role In Managing An Inflationary Economy - Essay Example

According to Poterba & Rotemberg (2007), there is a positive correlation between tax burdens and inflation rates (p.1). In other words, when tax rates increase inflation rate also increases and vice versa. Since Government is responsible for fixing tax rates in a country, they can definitely control the inflation rates with the help of adjustments in tax rates. For example, when the government increases taxes on petroleum products, the prices of petroleum products increase, and subsequently the prices of all commodities increases. It should be noted that price hike in petroleum products may increase the transportation costs of the commodities and hence prices of commodities increase. Only the government can effectively interfere in such situations to control the prices of commodities by controlling the prices of petroleum products. Han & Mulligan, (2001) argued that inflation is evidence of a government that cannot make credible promises (p.9). Price hikes always make ordinary life difficult. The credibility of the government will be lost when price hike happens in the country. It should be noted that the governments will lower the interest rates to control inflation. Lowering of interest rates will help the public to borrow more from the financial institutions so that economic activities may increase. Increase in economic activities may bring the inflation rates down. At the same time, lowering of interest rates may cause problems to the investors as they may not get adequate returns