How does a country get out of inflation?


How does a country get out of inflation?

In: 1

Everyone joins the let’s each burn a $50 bill festival. Problem solved. Maybe the ratio is different though.

Stop whichever situation caused the inflation. If it’s due to too much money printing or low interest rates then stop printing or raise interest rates. If it’s due to supply issues then open up more infrastructure/producers so that those supply issues are eased.

In the current situation. Oil is at too high a price which makes things like food skyrocket the answer is pump more oil until the price per barrel plummets. Lower oil prices mean deflation.

There are a few ways.

The first is to identify the cause. Right now in the US inflation is high for a few different reasons, but one of them is that supply chain disruptions have artificially restricted supply–if you haven’t noticed, a lot of stores have empty shelves because they can’t get the stock. Another is oil–the war in Ukraine has caused it to spike since that area is energy-rich, although this is very recent and inflation started a while ago, so it’s not a cause but it will make it worse/longer. The labor shortage also contributes. Another is the stimulus payments finally filtering through the economy. None of these are permanent, structural changes, and chances are if we do nothing at all this will correct itself–not immediately, of course. (A quick caveat is that some things–like wage rates and contracts–might get “fixed” right now in a high-inflation world, and thus perpetuate inflation, which is always possible, but that’s outside the scope of the question.)

(Also, quantitative easing may have caused it as well, but this is in dispute and outside of ELI5.)

True inflation, at its core, is largely a function of the money supply–i.e., the Federal Reserve. They try to target a 2% inflation rate, which is good for reasons we won’t go into here. If it’s too low, they set rates to increase it; if it’s too high, they change the rate to arrest it. Usually this is pretty mechanical and not very newsworthy.

Now, the fear is psychological. If people don’t believe that prices will stabilize, they start making decisions that will perpetuate the cycle–especially if they don’t have faith in the government to address it. This is why you see some nations with hyperinflation–they don’t have any faith that the government can fix it, so the problem feeds on itself.

One of the most effective ways to stop all this is to spike the interest rate hard. When you do so, you can stop inflation in its tracks; however, this has the rather unfortunate side effect of causing a recession. This is effectively what happened in the early 80s–the 1970s saw double-digit inflation due to an increase in the money supply (LBJ didn’t want to raise taxes to pay for Vietnam or the War on Poverty, so turned on the presses instead) and then was exacerbated by the oil shocks of OPEC. We then had eight-odd years of unmanageable inflation until the Federal Reserve increased the rate dramatically, which caused the recession of 82-83.

Ideally, in our current state, a modest change in the interest rate along with some easing of policies in other ways will probably do the job and once the supply chain and labor markets settle down things will revert to normal relatively quickly. If not, and it persists for a few years, we might have to “force” a recession so we don’t repeat the same mistakes.