Policies to Control Inflation

Exam code: 2281

Written by: Ashika|Reviewed by: Caroline Carroll|Updated 2 July 2026

Demand-pull inflation is best addressed using contractionary demand-side policies
- Contractionary fiscal policy and contractionary monetary policy aim to reduce total (aggregate) demand in an economy
- If total demand for goods and services decreases, there will be a fall in the general price level, thereby reducing the level of inflation
Total demand can be decreased through any policy which decreases one of the components of real gross domestic product (rGDP)

Broad policy type	Specific policy	Explanation
Contractionary fiscal policy	The government increases corporation tax	Firms pay more tax → firms have less profit → firms invest less → rGDP falls → inflation decreases
Contractionary fiscal policy	The government decreases expenditure on national defence	Government spending decreases → defence firms receive fewer orders from the government → national output falls → inflation decreases
Contractionary fiscal policy	The government increases personal income tax	Households have less discretionary income → consumption decreases → national output falls → inflation decreases
Contractionary monetary policy	The Central Bank increases interest rates	Household repayments on existing loans rise → households have less discretionary income → consumption decreases → national output falls → inflation decreases
Contractionary monetary policy	The Central Bank decreases the money supply by stopping quantitative easing	Firms receive less money from the sale of bonds → investment decreases → national output falls → inflation decreases

Demand-side policies are more effective in the short term at dealing with inflation caused by a rise in total (aggregate) demand
They are less effective at dealing with cost-push inflation
One conflict caused by contractionary policy is that reducing demand-pull inflation also reduces output and employment
- This could increase unemployment

Specific supply-side policy	Explanation
The government reduces regulation on the oil and banking industries	Regulations removed → costs of production decrease as firms no longer need to spend money meeting requirements → national output (total supply) rises → inflation reduces
The government changes migration policies to allow more workers into the country	More workers move into the country → the price of labour (wages) falls → costs of production reduce for firms → national output (total supply) rises → inflation reduces
The government builds a new rail network serving ports and airports	Speed and capacity of transport infrastructure is improved → costs of production decrease as firms benefit from the improvements → national output (total supply) rises → inflation reduces

Supply-side policy tends to be long-term and is highly effective in reducing price levels in the long run
They do not help deal with inflation caused by demand-side issues
- Not useful for short-term inflation – if prices are rising quickly due to demand-side pressures (e.g., after a stimulus), supply-side policies are too slow to help
They can be expensive to implement – as they can require high government spending in the short term (e.g. for investment or subsidies)

Policies to manage inflation