Inflation and Government Monetary and Fiscal Policies - Essay Example

College: Inflation and Government Monetary and Fiscal Policies Introduction Monetary and fiscal policies employed by various governments around the world imply that inflation is a normal occurrence in many economies all over the world. There are many causes of inflation, which stem from the governmental regulations on money spending and other means of controlling consumer purchasing power. In many cases, inflation is largely an occurrence due to shifting cycles in business, which necessitate introduction of various monetary and fiscal policies and regulations to control. Rates of inflation differ and thus require different measures for control. Some inflation rates are acceptable while others are not. Inflation has a direct impact on the national economies by influencing change in various economic elements. Article summary The article states that the rate of inflation in U.S. for the first quarter of the year has continued to rise. This is after the release of the price index, which shows an increase in prices of goods have continued to rise significantly. This has increased inflation as prices of major products like food and trade services record increased prices. The increase in inflation has spurred mixed reactions from economists who opine that the trend may cause acceleration in inflation. However, the U.S. economic growth and the state of economy are not strong enough to support rapid inflation acceleration. The increase in prices is against the government and economists’ expectations, which may reflect on the reactions of the federal government attempts to curb the rising inflation. With inclusion of the services and construction industries, the prices increase trend is unpredictable. Economists have raised concerns about the prices increases citing bad weather and suspected picking up of inflation rates as two major causes of the observed prices increase. Economists argue that the increase in producer prices is because of reactions to slow wage growth, which has increased demand for the major producer products (Mutikani n.pag). The Producer Price Index (PPI) will continue to increase in the second quarter of the month with prices of products and services like energy, foods and trade services increasing significantly. This issue is made complex by the increasing consumer sentiment index, which increased to 82.6% from 80.0% in one month. This will cause increased demand and thus purchases. The index also indicates that the demand for durable goods like automobiles will increase. The existing low inflation is particularly healthy for the growing U.S. economy and the Federal Reserve monetary policies back the rate of inflation. However, rising inflation costs will force the Federal Reserve Bank to increase the interest rates to recover the input they have injected into the economy to help it stabilize. The rising prices are the most needed economic aspect in stabilizing the growing economy of U.S. The Federal Reserve is expected to introduce tight monetary policies as one way of containing the rising inflation, and raising interest rates to curb increased purchases as well as reducing the amount of money injected into the economy to help in economic growth. Despite these measures, the drought persisting in the West will continue to force the PPI index upwards, creating more demand, and consequent rise in inflation (Mutikani n.pag). Inflation, causes, and effects Inflation is defined as the increase of prices of products and services over a period. The increase in prices causes an unprecedented dropping of the value of money. For example, if a car’s value was $3,000 in 2011, and it costs $5,000 in 2014, then this implies that the effects of inflation have pushed the prices up. Inflation is permanent and whatever measures taken to reduce its effects cannot return the money value to its initial value. Inflation is highly influenced by the Consumer Price Index (CPI). CPI is used to measure the purchasing power of people, which is expressed as a percentage based on collection of products and services bought in a given year. Accounts for all different types of products and services bought by a typical family in a year. CPI is used to calculate the rate of inflation yearly. U.S. CPI for the first quarter appears to be on the rise, which implies that the inflation is also on the rise. In addition, CPI is used as a component of measuring the Gross Domestic Product (GDP), where CPI effects on the money value directly affects the GDP. This indicates that the current situation of economy and GDP is U.S. is volatile and GDP is set to go up as the inflation goes up (McConnell, Brue and Flynn 13-14). U.S. is suffering from a demand-pull inflation, where the drought in the West has reduced production, but the demand of the products is still high. This implies that the rate of unemployment is low. Although the situation in the country remains stable as at now, the current rate of inflation and soaring prices may call for strict measures in monetary and fiscal policies to regulate the rising rate of inflation. There are serious consequences for various people involved in the production, services, and lending industries if the recent rise in inflation rates is anything to go by. One of the most problematic issues will be the country’s return to the past economic crisis. Serious concerns about the lending, construction and shares investments industries are however not a problem as the consumer sentiment index shows consumers’ contentment with the current conditions of the economy. Although the situation of the U.S. economy is not much of a problem as at now, the low rate of inflation is worrying the fiscal and monetary policy controllers. This is due to the effect it has on GDP and foreign exchange value. As at now, the value of the U.S. Dollar against other currencies is not strong. This is due to the past high inflation rates and recession of the economy, which forced the Federal Reserve Bank to back up the economy (McConnell, Brue and Flynn 15). As it stands, the Federal Reserve Bank must hope for increased rates of inflation to recover the money invested in the efforts to help the economic recovery. The increase in prices is thus a welcome move for the Federal Reserve Bank to increasing the inflation rates, stepping up on monetary and fiscal and monetary policies, and intervening on the lending industry to control the interest rates. These moves are aimed at enhancing the appreciation of the dollar against other world currencies. Within the discourse of inflation, demand and supply, the CPI plays a very significant role. CPI determines the aggregate demand and aggregate supply, which affects the Real National Output (RNO). While CPI and RNO plays it out at the level of national production, other factors like market demand and supply are relegated due to lack of consistency. The first quarter of the year represents considerable months for assessing the CPI and thus, is useful in assessing the RNO, which in this case appears to be increasing with an increase in CPI. According to the article, the Consumer Sentiment Index (CSI) is relatively high, which implies that consumer confidence is also high. Consumer confidence is one of the factors that affect total spending. This implies that, with high CSI, there is high consumer confidence and thus high spending. Increased spending implies a high rate of inflation. Increased prices do not affect consumer spending, and thus are useless in reducing the rate of inflation. Consequently, the economists who predict increased rates of inflation in the future are on the right track. Prior to the first quarter, the Federal Bank Reserve was operating on loose monetary and fiscal policies to give time and support to enable the economy rise from a recession. These policies also allowed the lending industry to operate in low interest rates, thus raising the capability of assessing money. This has affected the rate of consumers’ purchasing power and customers’ expenditure both in consumables and durable goods. The aggregate supply is also dependent upon the CPI. Although, various schools of thought differ on the effects of CPI, prices and total production, it is evident that the aggregate supply depends on the three factors. Further, the cycle of the economy also dictates the pace of aggregate supply. In the case of U.S. state of economy, it is evident that the aggregate supply of products and services is highly affected by the prices volatility and the total production in the country. In less than three months, the prices have shifted significantly, with changing total production, which has had a net effect on the aggregate supply of goods. On the other hand, government monetary and fiscal policies have also affected the total production, price levels, and thus the aggregate supply in general. One of the most striking features in the relationship among the three economic aspects is the volatility of how changes affecting one of the aspects reverberate through to the other aspects. For example, government’s monetary and fiscal policies have affected the total production, which has affected the the aggregate supply. The aggregate supply has affected the increase in prices. The effect is cyclic in that a change in one of the aspects also introduces changes to the others and so on. The U.S. Federal Government and the Central Bank are counting on increase in prices to raise the rate of inflation and enable them to step up on regulations as one way of recovering invested money. In a Neo-Keynesian argument, it appears that the U.S. government is right, as only the price levels can be more stable as compared with other aspects like total production and unemployment rates. Further, the government’s tightening of monetary and fiscal policies is very crucial in helping the U.S. economy back on track. Not only are government intervention central in stabilizing economy, they also act as major factors that cause a change in aggregate supply. In the first quarter, the government intervention in the economy has been relaxed and aimed at helping the economy recover. This involves the relaxation and subsidizing costs involved with production of major products and services like food products and the construction industry. However, it appears that these interventions within the course of the first quarter are not efficient enough to cater for the needs of regulating the aggregate supply, which has consequently changed. A major cause of the shift in aggregate supply is the rise of prices of imported products. Government’s early intervention that slashed down the lending rates has significantly affected the aggregate supply against the expectations of many economists. This is in addition to the low lending rates, the ‘ultra-easy monetary policies’ has had effects on the regulation of key industries that are primary producers of products and services (Mutikani n.pag). However, in the wake of increasing prices, economists suggest that the current high demand for products and services should stabilize the economy, coming from a period of low demand. Although, the current mix of factors like increased demand, rising of price levels, low aggregate supply and demand, and high consumer sentiment index are triggers of rising inflation rates, the U.S. economy cannot support the rise, as these are deliberate efforts to revamp the economy. Currently, the U.S. federal government’s debt is high, which implies that the Federal Reserve Bank and the U.S. Central Bank have to regain the budget deficit created by the interventions in the economy. As suggested by economists, the low inflation rates imply that the government must continue spending on the stabilization of the economy, which raises the national debt and increases the budget deficit. Thus, it is prudent that the U.S. government reduces the amount of money invested in revamping the economy and recovers the already invested amounts. Increased Producer Price Index (PPI) offers the government a chance to tighten the monetary and fiscal policies allowing it to start reducing its investment in the economy and start ploughing back the already spent (Walstad 32). Conclusion The article highlights the volatile nature of price levels, demand, customer sentiments, and other major economic aspects that influence inflation rates in a country. As the U.S. economy recovers from a recession, the increasing PPI have raised serious concerns about the future inflation rates in the country. However, the rising inflation rates offer an opportunity for the government’s monetary institutions to regulate the economic stability. This will create an avenue for the government to cut the amount of money spent in revamping the economy as well as recovering the already invested money. This will in turn affect the budget deficit and lower the national debt. Works cited Aggregate Demand and Aggregate Supply: The Pseudo-Market Macroeconomic Model. 10 Apr. 2013. McConnell, Campbell, Brue Stanley and Flynn, Sean. Macroeconomics. 18th Ed. New York: McGraw-Hill Higher Education. 2011. Print. Mutikani, Lucia and Leong, Richard. Producer Inflation Accelerates in March. The Chicago Tribune, 11 Apr. 2014. Web. 17 Apr. 2014. Walstad, William. Study Guide for Microeconomics. New York: McGraw-Hill Higher Education.2011. Read More