In the previous article, we looked at what inflation was and what potential problems it can create. Now, we will explore the role of the government and the Bank of England in fighting this.
Meeting the inflation target is mainly the role of the Bank of England, which means monetary policy. Fiscal policy, which is used by the government, therefore is not intended to affect inflation, but can still have indirect consequences. (We will look at monetary policy and fiscal policy in future articles).
Monetary policy primarily affects demand-pull inflation and is very useful in countering this form of inflation mainly by raising interest rates. Interest rates are set by the Bank of England and determine the return on savings or the cost of borrowing. If the cost of borrowing rises, it is more expensive to spend, which reduces consumption and thus AD, causing an inwards shift of the AD curve and a reduction in the price level.
Fiscal policy also affects demand-pull inflation, as fiscal and monetary policy are both demand-side policies. However, in this case it would be an increase in taxes (reducing consumption) and reduction in government spending. Reducing these two components of AD causes it to shift inwards and lowers the price level.
However, when it comes to cost-push inflation, which the UK is currently experiencing due to Russia and China, it is very difficult to do anything, as this is supply-side and the problem occurs outside the UK – it is outside our control.
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