Answer to Question #190023 in Macroeconomics for KAWONGa

Question

(a) Describe five economic effects of continuous, moderate inflation.

(b) How might governments use monetary policy to reduce the rate of inflation?

Answer 1

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A]

Moderate inflation will foster economic growth.

Mild inflation helps the economy expand, but excessive inflation stifles it by increasing the cost of development projects. While a small amount of inflation is unavoidable and beneficial in a developing economy, a high rate of inflation tends to delay capital accumulation and create uncertainty, lowering growth rates.

It encourages people to spend rather than save money, which is beneficial in a down economy inflation.  Moderate/continuous inflation promotes stability and allow businesses to spend and take risks.

 Fall in real wages. It can also act as an economic lubricant, allowing wage and price adjustments to be made more easily in the face of fluctuating demand. In certain cases, continuous inflation will result in a decrease in real wages. Real incomes decline when inflation is higher than nominal wages.

If an overhang of debt is holding back growth and job development, it's good for debtors – and therefore good for the economy as a whole.

Investors: Investors of equity shares benefit from higher dividend rates as a result of higher company earnings, as well as the increased valuation of their stock portfolios. Bondholders, on the other hand, lose because they receive a fixed interest rate that has already depreciated in real terms.

B}

The Central Bank and/or the government are in charge of inflation. There are a number of methods that can be used to keep inflation in check, which include monetary policy:

Monetary policy

During a time of rapid economic growth, the economy's demand will outpace its capacity to meet it. Firms respond to shortages by raising prices, resulting in inflationary pressures. This is referred to as demand-pull inflation. As a result, reducing aggregate demand (AD) growth could minimize inflationary pressures.

Higher interest rates reduce demand in the economy, leading to lower economic growth and lower inflation.

Control of money supply –there is a close link between the money supply and inflation; therefore, controlling money supply can control inflation in that reduction of money in supply will reduce the AD thereby leading to low pressure put on demand and supply.

Changes in reserve requirements. Commercial banks by law hold a specific percentage of their deposits and required reserves with central bank. This reserve requirement serves as a brake on commercial banks' lending operations: the Fed may affect the amount of money available for lending, and thus the money supply, by rising or decreasing this reserve-ratio requirement.