The Government's Control of the Rate of Inflation within an Economy - Coursework Example

With reference to the UK, examine and discuss the methods open to a government to control the rate of inflation within an economy. Inflation is a symptom of disease, of a general breakdown of the economic body. It results from an excess of money or from an excess of income, of wages, of diversion of supplies to the war economy, or results from large exports to foreign countries, or from lack of confidence in the currency, or from an inadequate tax system--to conclude without an over-all study that any of these is the cause, is unsound investigation. Governments can regulate the rate of inflation in many different ways including the interference in markets with the effect of raising prices or lowering prices though the number of actions. According to the Office for National Statistics (ONS) inflation in the UK rose to 2.2 per cent in January 2008, 0.2 per cent above the governments two per cent target. The consumer price index (CPI) figure is higher than in December, when it was 2.1 per cent. Inflationary pressure came from increases in the cost of fuel and food, as average petrol prices rose by 1.3p in January to stand at 103.9p per litre, while food prices fell by less than last year. Clothing and footwear prices dropped over the period, as retailers discounted heavily in an attempt to encourage shoppers to spend money after a subdued Christmas. Retail price index (RPI) inflation rose to 4.1 per cent in January, up from four per cent in December. Although rising utilities bills and an increase in producer price index (PPI) inflation will keep upward pressure on inflation, the drop in demand for consumer products - such as clothing, footwear and electricals - seen in January could offset the higher food and fuel prices, analysts believe (Office of National Statistics 2008). All these price changes and index raises are the results of the government interference in the economy that will be specified later in this paper. According to the authors of Maunder et al (2000), the ways to interfere into the inflation rate in the company are few of the following. Balancing the state budget Balancing the state budget is viewed by the economists as the way to help ease inflation. More efficient way is to keep the state budget ath the surplus and to hold expenditures at a low level. Budget can also be balanced by cutting taxes, and then trimming expenditures enough to make outgo match income. Tightening Money Tight money is probably the anti-inflationary weapon that is most widely used by capitalist economies today all around the world. By tight money it is meant holding down the ability of banks to make additional loans, so that household or businesses borrowers find it much more difficult--and much, much more expensive--to take out a loan. Tight money certainly slows down the pace of economic buying and producing. To a lesser extent it also slows down inflation, although there is no iron law that says prices must fall just because less is being produced or bought. Mainly the result of tight money is to intensify competition in a sluggish business setting, and that may bring prices down or stop them from going up: the bargains in air fares may be an example of this. The difficulties with tight money are is that the impact of credit stringency is very uneven--dealing serious blows, even death blows, to small business; leaving big business, with its powerful credit sources, relatively unscathed. Another problem is maintaining a steady monetary policy against the immense counterpressures that credit stringency brings. Small business people and labor unions and house buyers do not stand passively by while high interest rates and closed credit windows deal them out of the market. Voluntary Controls One of the easiest and least intrusive kinds of controls is to suggest limits for wage and price increases. The idea behind this policy of guidelines is clear and correct. If everyone would agree to limit his or her increase in income to, say, 5 percent, the inflation rate would promptly drop and no one would be any worse off. A collective decision like that would slow down the escalator, but would not change our respective positions on it. The problem is making a voluntary incomes policy stick. Unfortunately, unless everyone cooperates, the scheme will not work, and the temptations to cheat are enormous. It helps everyone see the field if all remain seated at a football game, and no one gains if all stand up. But if everyone does stay seated, the few cheaters get the best views; whereas if everyone stands, the few law-abiders get the worst views! Voluntary controls fail for the same reason: nice guys finish last. Therefore, a number of schemes have been devised to make adherence to such programs profitable (not compulsory), as well as patriotic. Among these are TIP (Tax Incentive Plans), which would levy tax penalties against companies that gave wage settlements in excess of guideline rates. If TIP encouraged all employers to stick to their guns, wage increases would stay in line, and no union will be disadvantaged compared with any other. Hence, there is a considerable amount of interest in such plans. Their difficulties are administrative rather than economic. They require a degree of supervision and intrusion on the part of government that is certain to create bureaucracy and to generate friction. That difficulty may be worth the price, however, if other measures fail. Mandatory Controls These type of controls require two attributes to be effective: (1) they would have to be permanent, or at least standby, so that they would not be on-again, off-again; and (2) they would absolutely require to be backed up by heavy taxes. Controls alone are just sandbags holding back a rising river. The necessary sluiceway to bring the river under control must be provided by taxes. The objection to mandatory controls is twofold. They are certain to cause a great deal of public irritation and they will pose an endless series of difficult questions in deciding how this or that price or wage rate should be adjusted as the economy grows and changes and faces new challenges. On the other hand, controls have one major benefit. More effectively than any other measure, they will halt the inflationary spiral. The halt may be only temporary, but it would provide a breathing space in which a really effective antiinflationary tax policy would be formulated, and in which the dangerous indexing and COLA arrangements could be trimmed way back. If other measures fail, therefore, and if inflation continues its threatening assault on our sense of psychological security, we may yet turn to this last remedy. Other government interferences to regulate inflation in the economy include a few following points discussing further (Beardshow, 1998). Agricultural Price Supports. Many of these programs set minimum prices on a variety of products. Apart from preventing prices from falling below the minimums, whether these programs tend to raise prices depends on whether they restrict supplies. Commodity loans for grains, without acreage restric tions, do not restrict supplies permanently. Thus storable grains under the commodity loan program can put a damper on price increase because supplies are not forever removed from the market. Agricultural programs illustrate a conflict between the goals of raising and of stabilizing prices. A possible argument for agricultural price supports is that they should stabilize prices but not raise them on the average. Farmers complain of feast and famine in economic conditions. But in setting out to stabilize farm prices, these programs ultimately raise them, because decreases are prevented and increases allowed—that is, a floor but no ceiling is set. To even out fluctuations without raising the average level of these prices, a government storage program would buy when prices were "low" and sell when "high" and would stabilize without raising the prices if the definition of "high" and "low" were related to a "normal" price that always matched the level that would prevail on the average in a free market. Transportation Regulation. Railroads, trucking, and airlines have long had their fares regulated by the government. While the original purpose was to prevent high monopoly prices, open competition has been largely stifled in these sectors by limiting entry, and rigid cartel prices have come to be the standard arrangement. The prices in almost all cases are undoubtedly higher than they would be with free entry and no regulation, and their flexibility in response to short-run fluctuations in demand has been reduced almost to zero. Maritime shipping is a special case where government regulations and market forces have priced the United States out of the world market, producing massive federal subsidies and quotas on use of foreign vessels. These raise shipping costs and prevent price declines. Import Restrictions. Foreign competition is limited by tariffs and direct quotas on a broad range of products far beyond agricultural items. Tariffs are equivalent to a sales tax, of course, and do not interfere with price flexibility unless the tariff is high enough, as it is in some cases, effectively to exclude certain foreign products from the domestic market. Quotas are another matter; they cut off an important source of competitive supply for domestic markets. This makes the domestic price higher and also more volatile in the face of shifts in domestic demand, if no other restriction is put on domestic price changes. Quotas are not, however, an appealing way to introduce price flexibility. As economists have long pointed out, import restrictions protect certain domestic jobs, but only at the expense of jobs in export industries and of the purchasing power of the consumer. Petroleum and Gas Controls. The government has long held down the price of interstate gas. Petroleum, on the other hand, presents a more complex picture ; prices were raised by the pre-OPEC quotas on imports and are held down by present price ceilings. In this important sector, removal of all controls would lead to an increase in prices, but they would thereafter become responsive to market forces much more directly than they are now. The sorry record of government regulation in this sector has been widely discussed and has long defied the best advice of economists for improvement and did so again with the recent energy bill. Environmental and Safety Regulations. These regulations operate to increase costs of production and hence to raise prices. They are the prime example of the governments contribution to inflation and the favorite complaint of those critics of government regulation who believe these measures were undesirable in the first place. They have a one-time effect in raising prices to a higher relative level, which can continue, however, for an extended period to keep prices rising. Investments to reduce factory noise and safety are just beginning and will continue for years to come. Much of this regulation is criticized for being too costly for the benefits produced, such as the publicized case of requiring expensive redesign of production facilities to reduce noise rather than simply providing earplugs. Automobile prices have been periodically raised for some years now and will continue to be for more years to come because of environmental standards. This is also true for industries, especially electric utilities, that must meet tightening environmental emission standards. Labor Restrictions. Government measures affecting the labor supply can have effects of considerable consequence for the simple reason that labor costs are a large part of the costs of production of most goods and services. Government policy supports and encourages labor unions, which have organized about onefifth of the labor force. By intent and design they may make wages higher in dollar terms than they would otherwise be. But, in addition, they considerably reduce the flexibility of wages, a consequence that has been widely discussed. Labor unions have also become a political force, most recently used to pressure the government to reduce imports that compete with domestically produced goods in unionized industries. A more general effect on the behavior of prices in the economy has reflected the growth of nonprofit sectors outside or inside the government, where the threat of profit or loss is not present to maintain efficiency and keep down costs. When nonprofit organizations are financed by the government in such a way that the services they provide are not directly paid for by those who consume them, there is reduced control over costs and efficiency. This is the basis of the argument that the growth of government is inflationary. These sectors are the government itself, such as municipal services and public education, and semigovernmental institutions, such as nonprofit hospitals and public housing. The effect is a kind of socialism in which no one is directly and individually concerned with and responsible for costs. In some of the specific cases cited above, particularly medical services, it can be an important contribution to inflationary pressures. Bibliography: Economics Explained, revised 3rd edition, Peter Maunder, Danny Myers, Nancy Wall, Roger LeRoy Miller, HarperCollins, 2000, 598 pages, paperback, 24.99, ISBN 0-00-327758-5, tel 0870 0100 442 “UK inflation rises above government target to 2.2 per cent “, Tuesday, 12 Feb 2008 11:43. Retrieved March 5, 2008 from: inthenews.com.uk Office of National Statistics. www.statistics.gov.uk/ BEARDSHAW, JOHN Economics a Students Guide. Longman, May 1998. Paperback. ISBN: Economics. Paperback Fourth Edition – 1998. Read More