4.2 Reasons For Inflation And Ways To Stabilize The Economy
4.2 Reasons for inflation and deflation and ways to stabilize the economy
Inflation can be defined as the increase in prices of goods and services over a period of time. Whereas, deflation is decrease in prices of goods and services over a period of time.
In an inflation situation consumers stop spending money (as much they are used to), due to that production declines, it leads firms to cut down employees and exports will be dampened. Overall there will be a decline in the economy. So to overcome this a country can either use Monetary or Fiscal policy to stabilize the economy. If the country choose to use monetary policy the central bank should balance the price and output levels. Since there is more money circulation in the economy the central bank will have to adapt
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The balance of payments is essentially a statistical statement that systematically summarizes, for a specific time period, the economic transactions of an economy with the rest of the world. A deficit in balance of payment account means spending more money on imports than its earning through exports. Which will lead to depreciation in its currency.
If the Central bank see there is a healthy level of depreciation in currency central bank intervene in the foreign exchange market. Interventions mean a central bank’s buying and selling of foreign exchange at times to influence the exchange rate or reduce its excessive volatility by enhancing supply of or demand for foreign exchange. E.g. if the CBSL is of the view that the rate of depreciation of the currency is at unhealthy level, it may sell foreign exchange, i.e., US $ at present, in the market so that the increased supply of US $ will reduce the depreciation pressure. (P.Samarasiri
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