Economics – Government and the macroeconomy - Inflation | e-Consult

Governments can use several policies to combat cost-push inflation, primarily focusing on reducing the underlying cost pressures. These policies aim to address the factors that are driving up production costs. Here are some examples:

• Wage Controls: While often controversial, governments might impose temporary wage controls to prevent wages from rising faster than productivity. This directly addresses the wage-push element of cost-push inflation. However, this can lead to labour unrest and inefficiencies.
• Subsidies: Governments can provide subsidies to businesses to help offset increased costs, particularly for essential inputs like energy or raw materials. This can help prevent businesses from passing on the full cost increase to consumers. For example, a subsidy on fuel could help transport companies.
• Monetary Policy (Interest Rates): Although primarily used to combat demand-pull inflation, raising interest rates can indirectly help with cost-push inflation. Higher interest rates reduce overall demand in the economy, which can ease pressure on supply chains and reduce the need for price increases. It also makes borrowing more expensive for businesses, potentially slowing down investment that could further increase costs.
• Supply-Side Policies: These policies aim to improve the productivity and efficiency of the economy. Examples include investment in infrastructure, education, and training. Improved productivity can help offset rising costs.
• Exchange Rate Management: If import costs are rising due to a depreciation of the domestic currency, the government might intervene in the foreign exchange market to support the currency's value. This can help reduce import prices.

The effectiveness of these policies can vary depending on the specific circumstances and the underlying causes of the inflation. Often, a combination of policies is needed to effectively manage cost-push inflation.