Page 99 - DMGT401Business Environment

Business Environment

Notes 3.5.5 Measures to Control Inflation

1. Monetary Policy: Inflation can be controlled by controlling the supply of money in the
economy. The central bank, through its monetary policy, can control inflation to a certain
extent. Through various measures like CRR, SLR, Bank Rate, Open Market Operations,
Moral Suasion (for details see unit of Monetary Policy), etc. The Central bank can increase
or decrease the supply of currency in the economy and thus control inflation to some
extent.

2. Price Controls: Another method attempted is simply instituting wage and price controls.
Through its fiscal policy, the central government can also check inflation. It can not only
influence the supply of money in the economy but also control or create demand - pull
inflation. It also influences the production and its cost, thus also influencing the cost pull
inflation.

Case Study Oil and New Economy

our cannot get more old economy than to fret about the price of oil. Although the
oil price is hard to miss when you come to refuel your car, economy watchers with
Yany sophistication are encouraged at every turn to pay little attention. For instance,
measures of “underlying” inflation exclude the oil price – too volatile, the argument goes,
and no longer all that significant, one is led to suppose. Yet theory and empirical evidence
suggest that the price of oil remains a fundamental driver of the business cycle. In all
likelihood cheap oil has played a big role in creating the appearance of a “new economy”
and dear oil, if the price stays up, may do more harm than many believe.
In Britain, the leading advocate of the view that oil still matters has been Andrew Oswald,
a professor at Warwick University. In an article in the Financial Times last year he went so
far as to claim that the so-called new paradigm is almost entirely an illusion caused by a
prolonged period of extremely cheap oil. Now that the price has soared and assuming that
it stays relatively high, he fears that the result will be a marked slowdown in the world
economy.

Mr Oswald is therefore a doubly unusual fellow: an easy-money new-economy sceptic.
Most new-economy sceptics want monetary policy in the United States tightened faster
(because they believe the surge in labour productivity will not last and that inflationary
pressures are building). Mr Oswald, in contrast, though a trenchant critic of the new
economy, believes that monetary policy should be on recession watch in both Britain and
America.
Mr Oswald, along with Alan Carruth of the University of Kent and Mark Hooker of the
Federal Reserve, published an article in 1998 which helps to makes the case for this view.
The starting point is the chart, which repays careful study. The association between changes
in the price of oil and, after a delay, changes in American unemployment is impressively
close. And the underlying model which Mr Oswald and his collaborators adduce is
persuasive and simple. They concentrate on the supply side (that is, labour-market)
implications of oil, rather than on the demand side effects. Dear oil raises producers’ costs
and squeezes their profit margins. To restore those margins, employers strive to cut
labour costs. At the aggregate level and for any given pressure of demand, higher
unemployment is the result: in effect, only with more people on the dole are workers
Contd...

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