Suggested Answers of BT2 Revision Package - ASKnLearn

Reason 2:If govtsaim toreduce &solveinflationWhile price ceilings reduces inflation, it does not tackle the root cause of inflation asit is a form of direct control on prices. For this purpose, other policies are required.Demand management policies are used to deal with inflation arising from thedemand side of the economy.Contractionary MP can be used. This occurs when money supply is reduced toincrease interest rates, so that consumption and investment spending will bereduced and hence AD will fall.Contractionary FP is another demand management policy where taxes areincreased to bring about a fall in consumption and investment spending. Togetherwith the fall in government spending, AD will fall. The fall in AD via both MP and FPwill bring about a fall in the GPL thus reducing demand-pull inflation.Supply side policiesThese are microeconomic policies aimed at increasing the quality and quantity offactors of production in order to raise the productive capacity of the economy.Policies which target at reducing the economy’s cost of production will help to bringdown cost-push inflation. These can be in the form of tax breaks to companies, R& D grants, fall in CPF contribution rates, reduction of trade union powers, moreinfrastructure spending, skills training programmes and so forth. When theeconomy’s capacity to produce is increased, price stability in the economy will berestored.However the above policies are not without its limitations:Both FP and MP are subjected to the unpredictable effects on AD. The rise in T andinterest rates may not cause a fall in C and I if the economy is booming as outlookand confidence is good. Hence AD may not fall to bring about the desired effect onthe GPL.Only the fall in G has a predictable effect on GPL but such a move is highlyunpopular although effective. Hence there might be a longer time lag for theimplementation of a fall in G as governments need to carefully consider itsundesirable social impact.Similarly most supply-side policies take a long time for its results on price stability tobe seen and to ensure such results, continuous funding is essential and this mayact as a constraint for governments who may already be running budget deficits.If the economy is concurrently beset with the problems of inflation and recession,then if contractionary MP and FP are used, they will be reducing inflation at theexpense of worsened unemployment rates. In such cases, if the government wereto apply contractionary FP and MP, the more effective it is, the worse will theimpact on jobs be. Hence when FP and MP is effective at reducing inflation, it mayamplify the problem of unemployment. This means the government may need toadopt expansionary MP and FP to tackle the jobs problems while resorting to eitherprice ceilings or currency appreciation to stem the price increases in the short run.