ECO 111: Principles of Economics (Year 1)
SANNI ANUOLUWA YETUNDE
is Responsible for Keeping Inflation Stable?
answering the main question, it is important to have a clear idea of what
inflation is and why it is important to keep the inflation rate low and stable.
can be defined the rate at
which the general level of costs for products and enterprises constantly rises.
It can also be seen as a state in which a lot of cash is pursuing few products
in the economy. Inflation makes money lose its value, that is, it reduces the
purchasing power of money.
Inflation can arise as a result of multiple factors.
Demand-Pull Inflation: This is when inflation is caused by an increase in
total demand. Aggregate demand in a country will rise if spending by
government, households and/or firms increases.1
Cost-Push Inflation: This is when inflation is caused by rise in cost of
production . It is passed on from firms to consumers in the form of price.
Monetary Rule: Inflation can occur when there is an increase in money
supply- the total amount of money circulating in the economy. An increase in
money supply without a corresponding increase in output will lead to inflation.
Imported inflation: increase in the price of imported materials leads to
the increase in the cost of production of domestically produced goods. Imported inflation may be set off by
foreign price increases, or by depreciation of a country’s exchange rate (imported
EFFECTS OF INFLATION ON AN ECONOMY
It imposes additional costs on firms: In cost push inflation, businesses’ profits are
squeezed. In demand pull inflation, increased spending increases their profit. However,
inflation generally leads to menu costs-all inconveniences borne by firms as
Reduces global competitiveness: during inflation,exported goods become less
competitive in international markets leading to a deficit in the balance of
Economic uncertainty: rising inflation makes it hard for households,
firms and the government to plan for the future. Households may be reluctant to
spend and firms will be reluctant to invest in noncurrent and current assets. These
factors can reduce employment and economic growth.
EFFECTS OF INFLATION ON BUSINESS
Shoe leather costs: firms will need to spend more time in order to
get the most reasonable prices. This may be tasking for small firms
Menu costs: this has to do with the resources firms have to put in to
change their price lists
Wage negotiation: firms will be under a lot of pressures by their
workers to increase salaries in line with the level of inflation. This may lead
to conflicts and demotivation in the work place
BENEFITS OF LOW AND STABLE INFLATION
the sales of goods and services sooner rather than later to avoid paying more
for the same product or service in future.
interest rates will usually be low during low and stable inflation, it
encourages borrowing. Money borrowed can be invested into businesses to
increase output and further economic growth.
be a reduction in the demand for higher wages as the expectations of the
workers and their representatives will be that there will be no decrease in
their purchasing power
who is responsible for the stability of inflation?
The primary objective
of the central bank is to ensure price stability and, therefore, curb
inflation. This is seen as the primary objective because the second core
objective of the central bank is to ensure a sustainable economy. No economy
can grow in the midst of price instability or inflation so it is safe to say
that the second objective cannot be achieved without the attainment of price
oversee the financial system and may also monitor other banks to ensure that
they are financially sound and are following wise management practices, since
the collapse of any bank can have serious financial repercussions throughout
the economy, especially the local economy (thismatter) (C.Spaulding,
the Central Bank Adopts to Moderate the Economy
fiscal policy: This is a
policy used by the government to reduce the aggregate demand by reducing
government spending and/or raising total taxation. If tax revenues exceed
government spending,the bugdet deficit will be cut,thereby reducing inflation.
However, may increase unemployment (Titley, 2012).
monetary policy: this
involves raising interest rates and/or cutting the money in supply to reduce
aggregate demand. Increasing the interest rates will reduce borrowing. Reducing
the money in circulation will reduce the amount of money firms and households
have to spend (Titley, 2012).
requirements: One of
the fundamental strategies utilized by every single central bank to control the
amount of cash in an economy is the reserve requirement. Generally speaking,
central banks command institutions to keep a specific amount of funds in
reserve against the amount of net
transaction accounts. (Bajpai, 2017).
market operations: central
banks can reduce the amount of money in circulation by selling government
securities and bonds to commercial banks and other institutions (Bajpai, 2017)