control inflation in free market?

Question

it's difficult to control inflation since in a free market. we cannot control price.

Answer 1

Yes, controlling inflation can be very difficult. In fact, government intervention to try and control prices and the economy may exacerbate the problem if the wrong policies, not just monetary but also fiscal, are enacted and if the markets are not allowed to adjust accordingly with the ebb and flow of supply and demand.

Pegging currencies to gold is not a cure-all to inflation. In the 15th and 16th centuries, European explorers were sending back ship-loads of gold "found" in the Americas. This increase in currency caused rampant inflation back home in Europe.

Answer 2

It is difficult to control inflation, but has been done.
One of the biggest problems is expectations.
My economics prof likes to tell the story of how Bush, on first inaugruation, stated that he expected an economy to downturn.
My prof felt like throwing his beer thru the TV.
If people had heeded Bush, they would expect an economic downturn and fear for their job and income. They save more, consume less and cause production to go down, which leads to job layoffs. This is a self-fulfilling prophecy.

By using monetary or fiscal policy (depending on circumstance) the government can shift the goods market equilibrium or the asset market equilibrium. This in turn will affect the output of the economy and the aggregate demand curve. In the short run prices are sticky, but will eventually respond to the shift. So if the economy is over heating, employment is above natural levels and inflation is occurring AND the country has a small open economy with a floating exchange rate, the government can use monetary policy to increase interest rates. This causes money to flow into the country to earn the higher interest rates. This leads to an increase in the exchange rate of the currency which leads to a decrease in exports and a contracting of the goods market. This causes a lowering of output, employment and puts a brake on price increase.

The Bank of Canada uses its monetary policy to keep the inflation rate between 1 and 3 percent and has been pretty successful so far in doing so.

But again, it can easily become unravelled with large shocks to the economy or bad policy or poor expectations

Peace

Answer 3

You can control inflation by allowing the production of the economy to match the value of each unit of currency. To do this you would need a market driven interest rate, rather than a central bank determined interest rate.

'Inflation is always and everywhere a moneytary phenomona' (Milton Friedman). General inflation and price rises is because of there is too much money which is printed by the banks (lent into existance) from thin air.

Is it fair to 'control' inflation, which is too much printed money created earlier by a mistake of too low an interest rate set by a central bank ruling the economy under central planning, by slowing the economy and dumping people into employment?

If the supply and demand of credit can be controled by market determined - market driven interest rates, rather than by a fudged version of central planning, there would, in thoery, be much less room for inflation.

The moment the money supply grew to a pace that far outstripped the underlying return from production, the market would demand a higher interest rate which would act instantly to lower the supply of money (raising the price of credit).

If the market set interest rate was *too high*, causing the money supply to shrink essessively, the demand for money would fall, lowering its interest rate (cheapening the price of money).

Here we would have the money supply growing - or falling exactly in line with the underlying production in the economy. There would be no inflation.

Answer 4

When currency was tied to gold inflation wasn't the issue. However, the opposite "depression" was so today we raise interest rates, print less money and other Federal inflation fighting tricks we hope will save us. However, I'm not an economist and that would be a very involved issue to study. The short answer is YES it's a real job controlling inflation...

Answer 5

I don't see it as being difficult. The problem is when the supply of money exceeds the growth of the economy. The currency not being tied to the gold standard allows the government to print as much money as they want. Which is the direct cause of inflation.

Answer 6

Inflation is simply the devaluation of money both domesticaly and internationaly. The US dollar is based on nothing more than faith in the US economy. The way to control infaltion is to slow economic growth and runaway credit spending. The key is to maintain a good standard of living. Business and govt should focus on keeping industry here.

Answer 7

Control the money supply, i.e. the value of money.