Government policy and inflation

Government policy for reducing inflation recognises the following possible causes of rising price inflation:

Demand-pull inflation occurs when the total demand for goods and services in the economy exceeds the total output or supply. As a result, prices will be forced up.

Cost-push inflation occurs when rising production costs are passed on to consumers in the form of higher prices. Production costs can rise either because workers push for wage increases above increases in productivity, or if the prices of materials and components rise.

Imported inflation is said to occur as the result of a fall in value of Russian rubble on the foreign exchange market. This will increase the price paid for materials, semi-finished, and finished manufactures, and services purchased from overseas.

Given these possible causes of inflationary pressure in the Russian economy, the following government policy measures to control inflation have been developed:

· Fiscal policy to control rapid increases in demand for goods and services by raising taxes and/or lowering government spending

· Using interest rates to stabilise the Russian rubble exchange rate to encourage exports and to reduce imported inflation

· Supply-side policies to improve the ability of Russian industry to expand output to meet demand and to reduce business costs and prices. These include:

· Reducing the size of government in terms of reducing the burden of taxation on consumers and producers and cutting government spending

· Competition policy to encourage price competition between Russian firms

· Privatisation: allowing private sector firms to produce goods and services formerly provided by central and local government

· Deregulation to remove out of date restrictions on competition and business

· Promoting skills through investment in education and training

· Support for innovation and new technology

· Removing barriers to international trade

· Encouraging inward investment

Fiscal policy has been used to control the level of total demand for goods and services in the economy. When demand was rising too fast causing prices to rise, governments would raise taxes and lower government spending to reduce the incomes of consumers and business. For example, corporation tax on company profits could be increased to reduce the money they had available to pay to shareholders and to use to invest in new machinery. Incomes taxes could be raised to reduce the amount of income consumers had to spend, and VAT could be increased to increase the price of some goods and services so that consumers could not afford to buy so many of them.

Fiscal policy is still used today to control the level of aggregate demand in the economy. However, some governments dislike trying to use fiscal policy to manage short run changes in the level of demand in the economy and instead place more emphasis on reducing the size of government over the long term.

The present government is committed to reducing the ‘size of government’ in terms of the amount of total tax it takes from the national income and the proportion of total expenditure accounted for by public spending. As part of this process, it is encouraging private-sector firms to run activities formerly operated by the government.

Ultimately the commitment to reduce government is linked to an aim to achieve a long-term balance between government spending and revenues and thereby reduce the need for government borrowing. It is argued that too much government borrowing ‘crowds out’ private-sector borrowing by firms, because the increased demand for borrowed funds by government forces up interest rates. As the cost of borrowing rises, firms tend to cut back their own investment plans.

The government has argued that high income tax rates are a disincentive to greater effort by workers. High corporation tax rates on profits also discourage firms from investing, because any additional profits generated are swallowed up in tax. The government is therefore committed to reducing the burden of direct taxation on the incomes of employees and industry.

Fears of higher price inflation tend to place downward pressure on the rubble exchange rate. This is because overseas investors, anticipating a fall in the purchasing power of their money held in Russia, will withdraw their investments and sell Russian roubles in return for other currencies. As with any other good or service, an increased supply of Russian roubles on the world currency market will push down their price. A fall in the value of rubble will raise import prices, and the cost of many raw materials and finished goods will rise also.

Interest rates can be used to stabilise the value of the Russian currency on world currency markets. Raising interest rates will attract foreign investment to Russia. As foreign currencies are exchanged for Russian roubles, the increased demand causes the value of rubble to rise.

Дата добавления: 2015-12-08