What are the ways to combat high inflation?

Demand pull inflation:

1. Contractionary monetary policy (Keynesian)

a. One positive: Economy moves closer to full employment level of output, central bank can adjust interest rates periodically, it is easily reversible.

b. One negative: Increased interest rate could see more investment and saving from abroad, causing currency to appreciate and harming net exports.

2. Contractionary fiscal policy (Keynesian)

a. One positive: Raises government revenue that can be used on other things, such as correcting market failures, or improving the equity in distribution of income.

b. One negative: can lead to a fall in real output/time lags

i. Note automatic fiscal stabilizers can ‘cool off’ an overheating economy.

3. Nothing should be done (Classical)

a. One positive: SRAS will automatically shift back in response to higher prices, so resource prices increase as spare capacity is used up and producers have to bid up remaining factors of production.

b. One negative: Will lead to Inflation.

Cost push inflation:

1. Decreasing corporate taxes (Classical)

a. One positive: Reduces inflation and increases real output.

b. One negative: may worsen equity in distribution of income, those in charge of corporations will make larger profits, and because government revenue will be lower so they cannot give as many unemployment benefits.

2. Abolishing minimum wage

a. One positive: Reduces short run costs for businesses, SRAS shifts out and can deal with new AD.

b. One negative: Abolishing minimum wage may decrease the standards of living in the economy as disposable income of many workers decreases.

3. Contractionary Fiscal policy

a. One positive: Will lead to a new equilibrium at a lower price level to combat inflation

b. One negative: Will lead to lower output in the economy, and higher taxes/lower government expenditure will not be met well by the public.

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