Which policy is applicable in controlling the inflation

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IMF Special Issues. IMF Staff Papers. At any time, you can update your settings through the "EU Privacy" link at the bottom of any page. These choices will be signaled globally to our partners and will not affect browsing data. We and our partners process data to: Actively scan device characteristics for identification. I Accept Show Purposes. Your Money. Personal Finance. Your Practice. Popular Courses. Key Takeaways Governments can use wage and price controls to fight inflation, but that can cause recession and job losses.

Governments can also employ a contractionary monetary policy to fight inflation by reducing the money supply within an economy via decreased bond prices and increased interest rates. Article Sources.

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This compensation may impact how and where listings appear. Investopedia does not include all offers available in the marketplace. Related Articles. In short, central banks manipulate interest rates to either increase or decrease the present demand for goods and services, the levels of economic productivity, the impact of the banking money multiplier and inflation.

However, many of the impacts of monetary policy are delayed and difficult to evaluate. Additionally, economic participants are becoming increasingly sensitive to monetary policy signals and their expectations about the future.

There are some ways in which the Federal Reserve controls the money stock; it participates in what is called "open market operations," by which federal banks purchase and sell government bonds.

Buying bonds injects new dollars into the economy, while selling bonds drains dollars out of circulation. So-called quantitative easing QE measures are extensions of these operations. Additionally, the Federal Reserve can change the reserve requirements at other banks, limiting or expanding the impact of money multipliers.

Economists continue to debate the usefulness of monetary policy, but it remains the most direct tool of central banks to combat or create inflation. Board of Governors of the Federal Reserve System.

Federal Reserve. Fiscal Policy. International Markets. Your Privacy Rights. To change or withdraw your consent choices for Investopedia. At any time, you can update your settings through the "EU Privacy" link at the bottom of any page.

These choices will be signaled globally to our partners and will not affect browsing data. We and our partners process data to: Actively scan device characteristics for identification. I Accept Show Purposes. Your Money. Personal Finance. In addition, armed with the measure of marginal adjustments in the policy stance, we consider their price impact on each of the narrowly defined sectors over different horizons during the period July —December Over a period that witnessed a diminished role for the common component in price fluctuations, we find that the response of prices to monetary policy shocks appears limited to a few sectors Graph 3.

Even after 36 months, the fraction of sectors for which the price response is statistically significant rises to only about a third.

Moreover, in terms of expenditure shares, the proportion is even lower across all horizons. In other words, the sectors whose prices are responsive to marginal adjustments in the stance of policy have a relatively small weight in the overall price index. Finally, the impact of monetary policy appears to be asymmetric: the fraction of sectors with statistically significant price responses is noticeably lower for expansionary monetary shocks across all horizons, compared with contractionary shocks right-hand panel.

Which sectors are relatively more responsive to changes in the policy stance? Not surprisingly, the bulk are in services, which on balance tend to be more sensitive to economic fluctuations "cyclically sensitive". This is the message of an analysis based on 17 sectors and the cumulative price impact of monetary policy shocks after two years Graph 4.

This box empirically examines how the importance of relative price "shocks" has changed across high and low inflation regimes.

It also notes what the analysis can say about current conditions, given questions about the implications of the recent spate of sizable price increases for future inflation. The construction of relative price shocks involves two steps.

In the first step, we obtain relative price levels by estimating the following regression for each narrowly defined PCE sector:. The above regression is estimated separately on two non-overlapping subsamples: January —December , a regime of high and volatile inflation; and January —December , a regime of low and stable inflation.

In the second step, we analyse how the pass-through of "salient" and positive relative price shocks to core PCE inflation — the Fed's preferred inflation measure — varies across the two inflation regimes.

All else equal, these changes are the most likely to pass through: being large, they are more noticeable; and being positive, they tend to constrain consumers more than decreases. Similar considerations may apply to the decisions of producers, which ultimately underlie changes in the prices of the consumer basket.

We implement these ideas empirically using the non-linear transformation developed by Hamilton to analyse the impact of oil price shocks on the real economy.

Specifically, we define a salient relative price increase in sector i in month t , denoted by , as. The pass-through estimates filter out the influence of business conditions, as proxied by the deviation of employment from an indicator of full employment , and control for lagged core inflation dynamics. The results indicate that the pass-through of salient relative price increases has declined substantially with the transition to a low inflation regime Graph A1.

The distribution of pass-through estimates 's for the low inflation environment is much more concentrated around zero; in addition, the estimates are generally not statistically significant during this period. Put differently, the likelihood and size of second-round effects from relative price increases have diminished substantially. To see how this analysis can shed light on the current outlook, we need to look at what is behind the recent elevated readings of overall inflation. These readings have been driven mainly by large hikes in the prices of a relatively small number of pandemic-affected goods and services.

In the United States and euro area, for example, the share of narrowly defined expenditure categories that registered outsize price changes in recent months — most of which involve goods and services affected by the pandemic — has increased considerably relative to recent historical norms Graph A2.

A key question then is whether these large price increases in a relatively small share of the consumption basket will feed into more generalised inflation. Indeed, the second-round effects from rising energy prices feature prominently in explanations of the rise in global inflation in the s.

However, we currently live in a different monetary policy regime. All else equal , the analysis in this box stresses that the recently observed price increases could be transient.

This is because, assuming that past patterns continue to prevail, the pass-through of relative price shocks into inflation would be small in the current environment in which inflation has been enduringly low and stable as part of a credible monetary policy regime. At the same time, the "all-else-equal" clause is important. In particular, the post-pandemic increase in inflation is rather unusual, having taken place as part of the post-Covid normalisation process and on the back of unprecedented fiscal and monetary stimulus.

The analysis here is just one piece of the jigsaw puzzle, which requires a much more holistic assessment eg BIS The views expressed are those of the authors and do not necessarily reflect the views of the Bank for International Settlements or the Bank of Thailand. Admittedly, the rise in inflation is not entirely due to increases in the prices of pandemic-affected goods and services.

Surging commodity prices have also contributed to higher inflation on the back of strong recoveries in China and in many advanced economies. The previous empirical findings raise important considerations for the conduct of monetary policy. In particular, they favour flexibility in the pursuit of inflation targets within a credible policy regime.

This may be especially so when inflation is hovering persistently below target, calling for a monetary easing. The first has to do with the central bank's ability to steer inflation.

When sector-specific price changes account for the bulk of variations in the general price index, monetary policy may face headwinds in moving inflation in the desired direction. One reason is that idiosyncratic price changes are less responsive to fluctuations in aggregate demand. In addition, adjustments in the policy stance affect only a narrow set of prices that together have a relatively small weight in the overall index.

The second set of reasons has to do with the desirability of seeking to steer inflation precisely or the need to do so. For one, not surprisingly, a substantial fraction of sector-specific price changes are transitory. Central banks can thus look through them.