The Level of Inflation in Britain - Case Study Example

Policies that could be used in a chosen country to meet inflation targets Affiliation Policies that could be used in a country to meet inflation targets Inflation can describe as a persistent rise in the general price of goods and services over a period. When the price level goes up a unit of currency purchases fewer goods and services. It is apparent that inflation reduces the purchasing power of a consumer. Inflation rate is the principal measure of price inflation, which is the annualized percentage in the general price index. Inflation influences the economy in numerous ways that can be either positive or negative. One of the negative effects of inflation includes a rise in the opportunity cost of holding money, which discourages savings and investment. Another harmful effect of inflation is shortages of goods as users start hoarding out thinking that their prices will increase in the future. On the other hand, inflation ensures that central banks adjust the real interest that encourages investments in non-monetary capital ventures. Economists believe that increased inflation rates and hyperinflation are because of excessive money supply in a given economy. However, excessive money supply does not imply that there is inflation. Some economists argue that under conditions of a liquidity trap, huge monetary injections compares to pushing a string. Views on the factors that determine low or reasonable inflations are more varied. These days, most economists prefer a low and stable rate of inflation. This paper focuses on describing the level and trends of inflation. It further digs out how inflation compares to the governments targets in United Kingdom. Further, it seeks and outlining the major causes of inflation and policies that will effectively solve the problem (Hall, 2009, p. 200). The level of inflation in Britain Inflation rate plays a vital role in determining the status of an economy. Countries with tremendous high inflation rates are termed to have hyperinflation, and when this happens, an economy is on the edges of collapsing. Even moderate inflation can swiftly erode the purchasing power and leads to uncertainty in businesses as they can hardly predict the future costs. In most cases, high rates of inflation lead to high-interest rates as creditors need to pay off for the decline in the purchasing power of future principal and interest repayment. A current inflation rate is calculated to two decimal places. It is said that there has been a fall in fuel and food prices since 1989. Inflation has declined to zero for the first time in Britain. The consumer price index (CPI) has recently dropped by 0.3 percent, bringing Britain to the edge of the spell of deflation expected in the future. Economist had predicted a slight drop to 0.1 percent, but a profound oil price fall and brutal price wars fought by supermarkets has brought the oil prices down by sixteen percent and food prices by three percent. The confirmation of that prices was flat gave Chancellor Osborne a chance to question Labor claims that United Kingdom is the center of a cost living calamity. Trends in inflation Britain inflation rates have been declining that the Central Bank of England worries that the director will give an explanation of the weakness in prices for the first time. There is a likely hood that inflation rates will continue being below one percent for the coming months. In case of a deflation, there will also be some concerns. Declining prices will encourage consumers to postpone purchases, and the permutation of the two aspects will endanger corporate funds, raising the number of insolvencies, thus reducing the prices and demand. Deflation is a miserable trap in which escaping becomes difficult. Deflation also prevents monetary policy from dropping real interest rates to make good growth and reduce unemployment. However, none of these situations has happened in Britain. There has been a high demand for products and services as well as a higher nominal GDP compared to the past. Additionally, there has been a lower rate of corporate liquidation compared to the last thirty years. Instead of delaying purchases to take advantage of reduced prices in the future, positive consumers are buying more and saving not as much. The declined inflation can be seen as a result of the lower global food and energy prices. Deflation is improving the living standards, and people forget the experience of the last four years, where households faced increases in consumer prices beyond their wages (News, 2015) How the inflation trends compare to the governments targets The Britain government set their inflation target as CPI of two percent for good reasons. The fear is that they may get problems dealing with high inflation and deflation. For instance, problems of dealing with deflation include raising the actual value of debt. With deflation, it is difficult for people to pay their debts. Consumers will spend most of their income on debt repayment. In addition, there would an increase in the real interest rates. Increased interest rates will discourage consumers from borrowing and saving. The Britain government aims at foreseeing an increase in the real incomes. Falling prices could easily achieve this government objective. Low inflation has also been. As a result lower energy costs in electricity and gasses that has been a government target over the years. Causes of inflation Inflation can be from both demand and supply or can arise from internal and external events. An increase in VAT would result in an increased domestic inflation. Inflation can also be caused by external factors such increased prices for oil and other imports. Demand-pull inflation is a type of inflation that occurs when the aggregate demand grows at an indefensible rate causing increased demands on the limited resources. Demand-pull inflation becomes harmful to an economy when there is boom with GDP growing faster than the long-term growth of potential GDP. Demand-pull inflation can be caused by numerous factors such as depreciation of exchange rate. An increase in the price of imports diminishes the foreign price of a nation’s exports. Another major cause of demand pulls inflation is high demand from the fiscal spur. If the government reduces the direct taxes, consumers are left with more disposable income that increases demand for products (Granville, 2008, p. 234). Cost-push inflation is another form of inflation that occurs when industries respond to the rising costs. Firms increase prices on the produced products to protect the profit margins. There are major causes which leads to the cost-push inflation such as rising labor cost, increased component costs, fall in exchange rates, existence of monopoly powers and increased indirect taxes (Hall, 2009, p. 250). Policies for tackling inflation One of the traditional methods of dealing with inflation is by using contractionary monetary policy. The goal of this policy is to decrease the money supply in an economy by increasing interest rates and decreasing bond prices. The people who have money will tend to spend less and save more (Russell & Heathfield, 1999, p. 354). One way to implement contractionary policy is by raising the interest rates using the Federal Reserve. Governments will often increase their Federal Reserve to the banks and in reciprocal; the banks will increase their interest rates. The increased interest rates will discourage consumers from borrowing hence little money in supply. The other way of increasing the reserve is by raising the amount of the reserve the bank are required to keep so as to cover their withdrawals (Baghestani, 2010). A supply-side policy is another major policy used to deal with the problem of inflation. This policy aims at increasing the long run competitiveness and productivity. For instance, deregulation and privatization are designed to make a firm more productive. Hence, in the long term, this policy assists in reducing inflationary pressures. Supply side policy best serves in the end. This system cannot be used to reduce a rapid increase in inflation. Supply side policy will lead to lower inflation rates by reducing cost-push inflation .promoting a greater competition in labor market is one of the supply side policy, which ensures the removal of restrictive policies and calls for labor market rigidities (Hall, 2009, p. 270). Fiscal policy is another measure was taken to prevent high rates of inflation. In this system, the government changes taxation rates and government expenditure that influences the aggregate demand. In reducing the inflation, the government increases taxes and reduces government spending. When the government increases taxes, it reduces the disposable income of the consumers and hence a reduced demand for goods and serves (Langdana, 2009). Other policy that can be used in reducing inflation includes adopting rational revenue and wage policy. During hyperinflation, there is usually a wage-price twist. To monitor this, the government should freeze incomes, wages profits, bonus, and dividends. This is a temporally and a short-term policy as there is a probability that industrialists and workers will criticize this. Therefore, the best alternative is increasing wages for increased production. Other methods that can be used includes: price control and investing in technology. Conclusion Inflation can describe as a persistent rise in the general price of goods and services over a period. It is apparent that inflation reduces the purchasing power of a consumer. Inflation rate is the principal measure of price inflation, which is the annualized percentage in the general price index. Inflation influences the economy in numerous ways that can be either positive or negative. Inflation rate plays a vital role in determining the status of an economy. Countries with tremendous high inflation rates are termed to have hyperinflation, and when this happens, an economy is on the edges of collapsing. Inflation can be from both demand and supply or can arise from internal and external events. It is, therefore, important to note the high inflation rates can cause serious problems to a nation, and therefore it is important for the government to take the necessary precautions. References Baghestani, H., 2010. Factors influencing Federal Reserve forecasts of inflation. Journal of Economic Studies, 1(1), pp. 191-300. Granville, B., 2008. Remembering Inflation. 3rd ed. London: Princeton University Press. Hall, R. E., 2009. Inflation: Causes and Effects. Chicago: University of Chicago Press. Langdana, F., 2009. Macroeconomic Policy: Demystifying Monetary and Fiscal Policies. 3rd ed. London: Farroh Langdana. News, BBC, 2015. Economy tracker: Inflation. [Online] Available at: http://www.bbc.co.uk/news/10612209 [Accessed 13 May 2015]. Russel, M. & Heathfield, D. F., 1999. Inflation and UK Monetary Policy. 2nd ed. Manchester: Heinemann. Read More