Fiscal policy is government manipulation of the economy through spending policy, taxes and borrowing. Governments can choose whether or not to borrow money or increase/decrease taxes, this is done in March (in Britain) by the Chancellor he/she expresses how his party will be using their money (usually on Health, Roads, Defence etc). A high government spending will add to aggregate demand meaning high inflation (assuming it exceeds aggregate supply). So in order to mitigate the problems of inflation, governments (on budget day) should look to decrease their spending. Governments can do this by spending less on public projects therefore less in spent and also means less people are employed (more unemployment will ultimately mean less inflation as people will not have the finances to spend money). Also government spending can be reduced on Health and Roads, this will again have the same effect as less people will have jobs therefore less money is spent. Governments can also choose to raise taxes, a rise in taxes will mean less disposable income. The smaller amount of disposable income will ultimately result in less consumption and lower aggregate demand. The conjunction of these government actions is known as “tightening of fiscal policy”. In China they are doing the opposite to tightening fiscal policy (know as expansionary policy), they are exercising high government spending to try and stimulate consumption. In Britain fiscal policy plays less of a major role, this is because of political stigma and monetary policy. Governments are scared to raise taxes because the attitude of the voter (they might not vote for them because of tax changes). Also because monetary policy has proven very effective central banks are more inclined to use it as a reduction technique. These are examples of how aggregate demand can be manipulated through fiscal policy.
Wage controls can be imposed by the government in order to reduce inflation. A wage control is simply a measure put in place by a government to protect employers and employees. The minimum wage is an example of a wage control, as it is a law that states every worker must be paid a certain amount. In a period of high inflation governments will try to force lower wages. Although to the discontent of the worker lower wages will mean lower production costs which ultimately mollifies cost push inflation. Wage controls are usually used on a brink of a recession as workers are less sceptical about accepting lower wages for job security. A good example of how wage controls have been used to lower inflation would be … Price controls are very similar to wage controls, instead of dictating what wages must be they instead dictate what prices should be. If there is a war prices are likely to sky rocket as supply can be seriously damaged as well as imports becoming increasingly hard. So in order to stop prices from rising too much governments tend to state that prices are not allowed to exceed £x. Price controls can cause some problems however as it means that there will be little/no competition and also because there is low supply it means a first come first serve model will be exercised. A good example of price controls would be in the USA when President Nixon tried to raise prices in steel. Nixon ordered that cheap steel production should be eliminated in order to force the consumer to buy more expensive products. Price controls can be used to alleviate cost push inflation by enforcing low prices.
One way to overcome inflation is to stimulate supply in order to meet demand, as I mentioned earlier one tactic is to lower income tax (therefore give more incentive to work). However classical economists have devised many other methods to encourage high production. One method is too weaken the power of trade unions (which can become a monopsonist when there is one buyer yet many sellers). This unity prevents workers from healthy competition as they have a all powerful leader, the trade union. As trade unions represent the workers they can help them achieve better wages, smaller working hours and are usually paramount in strikes, overall production will reduce. That is why classical economists argue trade union power should be cut because by doing this you can stimulate supply and help combat inflation. Although the counter argument to this is smaller hours and better pay can actually help production as it creates a happier worker who is less fatigued and happier to work. Also trade unions are a more organised way of voicing concerns, if it were left solely to the worker it could cause chaos. Classical economists also argue that state welfare or unemployment benefits should be reduced. Why would a worker take a low paid job when the government are handing out the same pay in return for doing nothing? The average worker is not going to accept a low paid monotonous job when they could receive the same money for not working. As benefits are too high it means less is being produced as there are less workers (and the labour force makes up a substantial amount of aggregate supply). The classical economists argues that governments should make benefits less appealing by slashing them and give more incentive to have a “low paid” job (I.e. Give more state support to those who maintain a poorly paid job). Another way to stimulate aggregate supply in labour would be to reduce taxes on labour, if corporations did have to spend as much money paying taxes for hiring workers then they would be more inclined to raise employment.
Another way to increase aggregate supply (in an attempt to mitigate inflation) is through increasing capital stock. Capital stock is factories, offices and roads basically anything physical that can be controlled through the state. A classical economist argues that it is the governments duty to create a working environment that is favourable to businesses. Instead of adopting interventionist policies governments should embody a “laissez faire” attitude. Laissez faire means “let it be“ it advocated little government intervention and letting markets and consumers/suppliers alone to decide resource allocation. To create this atmosphere the state should cut inheritance tax so small businesses that are “in the family” don’t suffer when a family member dies and the business and assets are bestowed upon another family member. Modifying the inheritance tax could result in either a smaller tax (in percentage I.e. a cut from 5% to 4%) or governments can raise the threshold (so you will not be taxed on small businesses only larger companies). Another way to help businesses develop is through reducing taxes on company profits, this means more is left for the company meaning more capital is left to invest in other ventures or making production more efficient. Classical economist also argue that governments should also cut taxes in employment, by doing this businesses are likely to be more incline to hire people as they will not face the burden of being taxed heavily. Another way to help businesses thrive is to reduce “bureaucratic red tape”. This “red tape” is governments legal restraints, planning permission is usually the biggest problem as it means companies aren’t allowed to expand offices etc. without council permission. An example of how red tape was cut would be Ruth Kelly’s decision in 2007 to reduce planning permission in certain districts of the UK. A final method of reducing government intervention and allowing freedom of growth would be through privatisation of the public sector. The state are not as qualified to determine resource allocation in comparison to the private market. Therefore state run organisation (such as the NHS in Britain) should be privatised to allow a consumer to attain what they desire and also allow services to expand and reinstalls the price mechanism which means clear actions can be taken to resolve inflation. The best example of mass privatisation of the public sector which resulted in phenomenal economic growth would be Margaret Thatcher’s policies in the 1980’s. Thatcher privatised many government enterprises (50 in total), including British Airways, British Steel, British Telecom and British Gas. This privatisation resulted in the governments revenue (through these enterprises) increasing from £2.6bn in 1986 to £7bn by 1989. Although this laissez faire attitude seems to resolve the crisis of inflation it does carry many negative repercussions. It can create monopolies as there is very little (apart from competition) stopping businesses dominating markets. These monopolies mean that consumers are unprotected and high prices are allowed to flood the market. Also the Wall Street Crash was a direct result of the neglect of the American government. There needs to be a balance between intervention and laissez faire or else inflation will rise.
In the goods market competition must be stimulated in order to increase efficiency of production therefore increase aggregate supply and mollify inflation. By allowing foreign businesses into the domestic market it means more competition is created, by doing this it will force companies to produce goods more efficiently to survive. This newly installed efficiency will create a larger aggregate supply. Governments can increase foreign competition by removing import tariffs (an import tariff is a tax on foreign goods which usually makes them less competitive in comparison to the domestic good). Governments should also aim to encourage smaller businesses to compete with larger firms on prices, as it means that instead of competing with businesses of similar capacity you are actually competing with the whole market which means the most efficient producer will prevail. Governments are also advised to adopt deregulation. This is the removal of laws which hinders growth of supply, similar to removing red tape, deregulation means producers have more room to grow and are not constrained by the law.
Exchange rate policies can also be used to influence and reduce inflation. An exchange rate is the value of a specific currency in the foreign currency market. For example the value of the Japanese Yen in comparison to the American Dollar. There are two types of exchange rates, the majority of countries have a floating exchange rate, this means it is determined through market forces freely, however interest rates and foreign currency reserves are usually used in a floating exchange rate to install some structure. Britain and America both operate a floating exchange rate. The other type of exchange rate would be a fixed exchange rate. This means the government will fix the price of their currency and not let other factors determine it. This method is exercised in modern day China. Floating exchange rates can be influence by two determinants. If interest rates are risen it makes the countries currency more attractive as its more profitable to save, therefore demand for that currency will rise meaning the value of the currency will also rise. Another way that exchange rates can be changed is through gold reserves and foreign currency reserves. Governments can sell their gold reserves for their currency this means that demand for the currency will rise which ultimately means that the currency will become stronger (in comparison to other currencies). Exchange rates obviously have a big impact on imports and exports this means that they can be used to resolve the problem of inflation. By strengthening the British pound it will make foreign imports cheaper. These new cheap imports mean that manufacturing costs will be lower as raw materials cost less. The lower manufacturing costs will ultimately mean lower prices. However a problem with high imports is it means aggregate demand for goods will rise, (as goods will be cheaper) so this could in itself actually cause demand pull inflation.
Inflation can be reduced through numerous ways, the most commonly used would be monetary policy, this is because its easy to modify as well as very effective. All the methods however are flawed, personally I would strongly advise not using “price controls”, governments do not possess sufficient knowledge on social aspects to dictate prices. Although in extreme situations price controls have to be used (like in a war) other then this they should be avoided as they are too dismissive of social implications. I agree more with the classical ideals as less government intervention does allow more businesses to prosper, it is much wiser to allow competition then to hinder it for inconsequential reasons. Although measures have to be put on businesses these should be a minimal as possible to allow free growth in a free market. A Keynesian would argue that state intervention and state stimulation is paramount to the mitigation of inflation and the growth of the economy. However state intervention has been practised in Britain through the labour government and was embarrassingly flawed. As long as governments protect the consumer while allowing growth of free enterprise inflation can be controlled, its when companies can’t compete and consumers halt purchases that an economy have problems. Although monetary is grossly overused it is probably the most effective method of overcoming inflation along with a moderate government who don’t adopt too interventionist policies. Although the outstanding panacea for inflationary worries is simply knowing what causing inflation, its no use for governments to adopt monetary policy when fiscal is needed. Transparency of the problem is the real cure for inflation.