Dealing with rising inflation
There are a lot of factors that may lead to a spike in prices, such as supply restrictions, which make it more expensive to create products and provide services, and happy customers who spend their windfalls from a booming economy at a quicker clip than manufacturers can keep up with demand. Combinations of these two factors often lead to inflation.
In most situations, individuals work to keep inflation rates within a target range that encourages economic growth while limiting the extent to which a currency’s purchasing value is diminished by inflation. Part of the onus for keeping inflation in check in the United States falls on the shoulders of the Federal Open Market Body (FOMC), the Federal Reserve’s monetary policy-setting committee.
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Price Controls
It’s possible to think of individual-imposed price controls as either a cap or floor on the prices of the things they apply to. With the use of price controls, wage push inflation may be controlled by the implementation of pay caps.
To combat rising inflation, Richard Nixon, then the president of the United States, instituted strict price restrictions that year (1971). Inflation reached its highest levels since World War II in 1973, and despite the price controls’ early popularity and general conviction that they were effective, they were unable to keep prices under control.
Contractionary Money Policy
Common practice now calls for more stringent monetary policy to reduce inflation. A “contractionary” policy seeks to reduce the quantity of money circulating within an economy through increasing interest rates.
The increased cost of borrowing has a chilling effect on consumer and company spending, which in turn slows economic growth.
Moreover, higher interest rates on individual securities slow economic growth by luring financial institutions and investors to acquire Treasury bonds, which provide a set rate of return that is guaranteed, rather of the riskier equity investments that benefit from lower interest rates.
Federal Fund Rates
Since the United States has never been in default on its debt, IOR is seen as a risk-free rate; hence, any rational lender should accept it as the lowest possible interest rate.
Because not all banks have deposit accounts with the Federal Reserve, this entity is necessary. By participating in the Overnight Term Reinvestment Program (ON RRP), these financial institutions may effectively purchase federal security in the evening and resell it to the Federal Reserve (Fed) the next business day.
Raising these rates causes banks and other lenders to charge more interest on riskier loans and move more of their funds into the Federal Reserve, where they are safe from loss.
Discount Rate
A loan from the Federal Reserve will cost you the discount rate. The Federal Reserve is the entity that issues these loans. The discount window is the name of the lending facility that is utilized to make these short-term loans. All Reserve Banks use the same discount rate, which is established by mutual agreement between the boards of directors of the individual Reserve Banks and the board of governors of the Federal Reserve System.
While the discount window’s principal purpose is to ensure the stability of the financial system by satisfying banks’ demand for short-term liquidity, the discount rate is yet another interest rate that has to be increased to rein in inflation.
Open Market Operations
OMOs are a tool the Federal Reserve employs to adjust interest rates by expanding or contracting the money supply, accordingly.
When the Fed buys securities, the notorious balance sheet expands, and when the Fed sells securities, it contracts. Buying securities increase market liquidity and pushes interest rates down, whereas selling securities has the reverse effect.
Conclusion
Individuals do not have a lot of options for fighting inflation. They have the power to set a price floor, but extensive price controls, which are needed to curb inflation, have a checkered history. Inflation control in the contemporary economy is accomplished mostly by contractionary monetary policy, although achieving a “soft landing” is notoriously difficult.
