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Zhang (2010) defines economic policy as the actions that a government should take to govern the economy of the country. This includes the systems that are crucial in setting government budget and interest rates. Economic policy also sets national ownership, the labor market, and various areas that have a close relationship with the country’s economy (Gillman & Harris, 2010). Making economic policy does not take place once, but economic policy makers keep making and revising the policies due to changes in the country’s economy. Inflation is among the changes that result in adjusting economic policies so that they can meet the country’s economic needs (Zhang, 2010). This discussion will consider inflation as the challenge that the makers of economic policy are likely to face in the future as well as the techniques through which they can meet the challenges.
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In the field of economics, price inflation or inflation refers to a rise in the level of cost of commodities and services over time. Originally, people considered inflation as the increase in the supply of money and they used to refer to it as monetary inflation (Zhang, 2010). However, debates concerning the causes and effects of inflation have resulted in its primary use in giving a description of price inflation. Other people also describe inflation as a decrease in the actual value of money, which means that the money loses its purchasing power. Once the level of prices goes up, the currency can buy fewer commodities and services than before. Economists determine price inflation by calculating the rate of inflation as the change in a price index expressed in percentage (Gillman & Harris, 2010).
Inflation brings about a number of adverse effects in a country’s economy. For instance, uncertainty concerning inflation in the future may discourage people from saving and investing their money (Gillman & Harris, 2010). Inflation can also shift income from fixed income to variable income. Fixed nominal expenses, such as wages and rents are likely to undergo erosion if they do not undergo inflation-adjustment. High inflation usually encourages hoarding because people will be able to purchase consumer durables, which store wealth (Zhang, 2010).
Economists usually agree that hyperinflation and high inflation rates take place because money supply undergoes high growth rates. People’s viewpoints on those factors that influence moderate inflation rates vary from one person to another (Gillman & Harris, 2010). Some people attribute changes in inflation to fluctuations in actual demand for commodities and services as well as in the available supplies, which refer to changes in scarcity. Nevertheless, there is consensus that in the end, when the increment in money supply exceeds the economic growth rate, inflation is the resultant feature (Zhang, 2010).
However, inflation can also bring about its own benefits to people (Gillman & Harris, 2010). A significant advantage of inflation includes allowing the monetary authorities flexibility and discretion to make use of monetary policy to meet shocks domestic economies. Zhang (2010) argued that this flexibility is extremely significant in market countries that are emerging because they are vulnerable to large shocks. According to Zhang (2010), inflation-targeting governments usually have built in flexibility so that they can be able to attain their target of inflation extended horizons and people characterize them as targeting flexible inflation.
Meeting the Challenge of Inflation
Many countries have put their efforts in controlling inflation or are preparing to control inflation once it takes place in the future (Gillman & Harris, 2010). Effective policies that can control inflation should focus on the fundamental factors that cause inflation in a country’s economy. For instance, if the primary cause is the demand for commodities and services, the government policy should reduce the aggregate demand levels. If the cause is cost-push inflation, then the government should control production costs to reduce the problem (Gillman & Harris, 2010).
Two fundamental monetary institutions have continued to be crucial for the monetary authorities to be able to keep inflation rates under control. One of the institutions is an institutional and public commitment to stabilize prices as the predominant long-run objective of monetary policy (Zhang, 2010). Governments can write institutional commitment into law because it is in the legislation of the central banks in many countries, and this is apparently significant in allowing the central bank to control inflation. It is crucial to know that laws may not be as influential as the commitment of the public and politicians to support the stability of price (Gillman & Harris, 2010). In this case, financial history is influential. Most of the market countries that are emerging have had a poor support history regarding the goal of price stability. However, since it is easy to overturn laws in these nations, it is not apparent that there will be sufficiency of laws (Zhang, 2010).
The other institutional arrangement, which is crucial for successful inflation targeting includes institutional and public commitment to the central bank’s instrument independence (Zhang, 2010). Instrument independence depicts the prohibition of the central bank from financing government deficits. It is crucial to allow this institution to establish the instruments of monetary policy without any intervention from the government (Gillman & Harris, 2010). In addition, it is necessary to insulate the monetary policy board’s members from the political processes by providing them with long-term appointments, as well as protection from discretional dismissal (Zhang, 2010). There is an enormous literature on the independence of central bank and the appropriate forms, but again history and political culture of the country is more significant than what the government writes down in the law. For instance, Canada’s central bank does not consider the entire independent because the Canadian government is ultimately responsible for the monetary policy’s conduct (Gillman & Harris, 2010).
Transparent discourses of the monetary policy’s conduct can make it extremely hard for the central bank of the country to follow expansionary monetary policy, as accountability shows that the central bank pays a lot of money if it engages itself in discretionary policy, which results in high inflation (Zhang, 2010). Inflation targeting must gain a support from the political and public support to constrain discretion. Inflation targeting is significant in focusing the public debate to support the focus of a monetary policy on long-term goals like price stability, as it has been the case in various inflation targeting nations (Gillman & Harris, 2010). However, the benefits demand magnificent communication skills and more transparency on the part of the Central Bank, which is politically complex environment in the market countries that are emerging. Apparently, excellent communication may fail to be significant in case of the incapability of the political environment to support the independent central bank, which concentrates on controlling inflation (Zhang, 2010).
In the contemporary society, monetary policies are attempts of government in the restoration and maintenance of growth and stability of the economy. Without putting these procedures into practice, people may as well continue living in the economic environment that is similar to the one in the past, which was full of crimes and chaos because unstructured banking system existed (Gillman & Harris, 2010). It is significant, that in order to avoid repeating history, people must first understand the history and gain knowledge from it. In addition, individuals can only maintain economic balance, if they can be able to understand banking history as a whole that results in the formation of the Federal Reserve, which is the tool for enacting monetary policies to govern economic policies (Gillman & Harris, 2010).