how does a country control/fix inflation?
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A macroeconomic system is very complex, but in very rough eli5 terms…
If the economy is stable, the government can have some influence in the inflation by manipulating for example, the federal funds rate (how much interest they’ll pay if you lend them money – which propagates to how much banks will pay as interest too). If interest rates are higher, more money goes to savings and less into circulation, people spend less, lowering demand for goods, prices go lower, less inflation. With lower interest rates, people save less, spend more, there’s more demand, prices go higher, more inflation.
Now, a crumbling economy with runaway inflation is a harder to control beast. I’ve been through one, in Brazil, the 80s-90s were crazy times. It peaked 80% in a month in 1990, going beyond 1500% a year.
Several plans to curb it falied, mostly because we already had an inflation “culture”: Everyone would keep marking up prices because they “knew” tomorrow’s money would value less. You could buy cheaper by reaching to products at the back of shelves, or simply peeling off some layers of price stickers (no barcodes then). Supermarket employees worked all day with sticker pistols, but didn’t manage to relabel everything. You would hear them coming, and grabbed the merchandise before they got to it. You had to buy all supplies for the month as soon as you got your sallary, as waiting for some days would mean you could buy less. We cut 6 zeroes from currency, or more. At some point I made 25,000,000.00 monetary units a month (don’t even recall what was the currency then).
Sooo in 1994 a magic trick was done by a Economy Minister (who later became president for two terms). A “parallel currency” was established. There was no legal tender, but it was a reference value, like if it was a foreign currency.
It was the URV (real value unit), and there was an “exchange rate” to out currency. The URV was rather stable, and a lot of things started having prices, fees, payments, etc, adjusted in relation to that (in other words, they would keep the same value in URV, but converted into the “normal” currency when you were to pay them). So the inflation culture was satisfied, as prices kept growing in our currency, but people now had a reference to adjust them – the URV. Then more and more things had their prices adjusted by the URV.
So after a while everyone learned to trust the URV as a “real value”, no matter what was the crazy conversion to our currency at the moment. Then at this point the government said: “Right, now forget the old currency, our new currency is the Real, and it’s exchange rate to URV is 1:1”.
Pure genius. Inflation obviously dropped immediately, as prices in Real were stable. We do have inflation now, but hyperinflation like in the 80s-90s never came back.
/u/jsveiga has a pretty decent explanation if your currency is inflated so far that you need to rebase it.
First, what causes inflation. One famous economist said, “Inflation is everywhere and always a monetary phenomenon.” Meaning that when money is being printed faster than the economy is growing, you have inflation. If it’s slower, then deflation.
Second, how do banks make money. Firstly they get money in deposits. They pay the depositor a small interest rate, and then they lend that money out at a higher interest rate. They always keep some money on hand to pay back depositors, this is called reserves. Generally their incentive is to have as little money in reserves as possible, that way they can put as much to work as possible. Also, banks themselves create money through lending. Suppose you deposit $10000 in the bank, and then the bank loans $5000 to Joe Schmoe for a car loan. You now have an extra $5000 in the economy, your 10k deposit, and the $5k car loan. The bank is holding the other $5k in reserve.
Ok, now on to the central bank. Nearly all countries have a central bank, the US central bank is called the Fed. Their primary tool is to adjust a lending rate called the Federal funds rate, this is a rate that banks (and credit unions) lend money to each other on an overnight basis. The Fed adjusts the federal funds rate by changing interest paid on reserves. Suppose in the last case the fed “raises the interest rate” from 0% to 5%. This means they pay money based on the $5000 reserve the bank has to the tune of $250. Suppose Joe Schmoe’s car loan was 5%. There is no risk doing business with the Fed, so after the rate hike, the bank would choose not to make a loan to him. This means the $10,000 in deposits, is not getting lent out, therefore new money is not getting created by the bank, therefore there isn’t inflation.
Obviously those numbers are made up to illustrate the case. Dang this is hard to ELI5.
The simplest way is by adjusting interest rates. Interest rates are the amount of extra money someone pays someone else when they borrow money and pay them back. They give them back a little more as an extra “thank you” for lending them the money.
When everyone has to pay extra on all their loans, there’s less money going around, so sellers have to drop prices in order to sell things.
A government can also increase taxes and give out less money.
There are many methods, and sometimes they are not always good ideas.
By increasing prices accordingly. Some things’ Price are government mandated, because they are necessary for people.
But on the US corporations are increasing prices so they can make more profit for the CEO, while they dodge taxes and cut suppress wages for workers.
Inflation is not any rise in prices. Inflation is inflation of a country’s money supply. A country makes more money. This causes prices to rise across the entire economy, because there is more money and each unit of money is worth less. To not have inflation, don’t increase the money supply. Or, if you want make your money supply inflation proof, go to something like the gold standard. If your money is tied to gold, the country can’t make money out of nowhere.
Inflation is caused by the government, anyone who tells you otherwise is ignorant or lying. Governments spend more than they being in, requiring them to sell bonds, or IOUs, in order to fund their budget.
Central banks create inflation by buying this government debt (treasuries or IOUs) with fake money, which is what is meant by printing money, in order to create liquidity in the market, because people don’t want to buy bonds from a government that doesn’t look like it can repay them with interest. They would demand a higher interest rate for the extra risk. But the Federal Reserve Bank, the US’s central bank, for example, will buy bonds with fake money so that the bond market stays liquid and lenders keep buying bonds. Because they are pumping more money into the economy but adding no actual value, there are more dollars to share the same total worth. Therefore, each dollar in existence becomes a little less valuable, which means you need more of them to buy goods and services. This is inflation.
A central bank can reduce inflation by raising interest rates, which means they have to sell those IOUs back to the banks they bought them from, thereby taking dollars back out of the economy, which means there are fewer dollars to share the total value.
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