When expenditure on goods and services exceeds output, inflation results. Prices may grow as a result of supply restrictions that raise the cost of making goods and providing services, or as a result of customers spending extra money faster than producers can boost production while taking advantage of an expanding economy. A combination of these two situations frequently leads to inflation.
Governments typically work to maintain inflation at a desirable range that fosters growth without significantly lowering the currency’s buying power. The Federal Open Market Group (FOMC), a committee of the Federal Reserve that determines monetary policy to meet the Fed’s objectives of stable prices and maximum employment, is mostly responsible for regulating inflation in the United States. Hawkish FED raises rates to keep inflation in check. While there is no surefire way to stop inflation, some strategies have shown to be more successful and cause less collateral harm than others.
- Price Controls
Price controls are imposed on particular items by the government as price floors or caps. Price restrictions can be used in conjunction with pay controls to reduce wage push inflation.
President Richard Nixon of the United States enacted extensive price restrictions in 1971 to combat increasing inflation. Although initially popular and thought to be effective, price controls failed to keep prices under control in 1973 when inflation soared to its greatest levels since World War II.
Most economists consider the 1970s to be sufficient proof that price controls are an ineffective tool for controlling inflation, even in the face of several intervening factors, such as the end of the Bretton Woods System, subpar harvests, the Arab oil embargo, and the complexity of the price control system of the time.
- Contractionary Monetary Policy
Contractionary monetary policy is more widely used today to combat inflation. By raising interest rates, a contractionary policy seeks to reduce the amount of money in an economy. Credit becomes more expensive as a result, which lowers consumer and company expenditure and slows economic growth.
By encouraging banks and investors to purchase Treasuries, which provide a specific rate of return, rather of the riskier equity investments that profit from low-interest rates, higher interest rates on government securities also hinder growth.
- Federal Funds Rate
The rate at which banks lend money to one another overnight is known as the federal funds rate. The Federal Reserve does not directly control the fed funds rate. Instead, the FOMC sets a target range for the fed funds rate and then modifies the interest on reserves (IOR) and overnight reverse repurchase agreement (ON RRP) rate to bring interbank rates into the target range.
IOR is the interest rate that banks get on their Federal Reserve deposits. IOR is regarded as a risk-free rate because the United States has never experienced a debt default; as a result, it is the lowest interest rate that a prudent lender should take.
