An inflationary monetary policy is a policy followed by a central bank, government, or other entity with broad control over an economy that leads to the growth of inflation. Banks and governments employ a variety of tools to manage inflation, most of which involve the supply of money in circulation. Most modern central banks seek to follow a modestly inflationary monetary policy at all times to promote stable growth and ward off deflation. In some instances, regulators may seek to increase the rate of inflation in order to spur growth or reduce relative debt. Governments in deep distress may also pursue profoundly inflationary policies when they are under extreme duress and must focus on very short-term objectives.
The tools used to manage inflation through monetary policy are generally indirect ones. Reducing the reserve requirement for banks, increasing the money supply directly, and reducing discount rates each serve to increase the effective level of money in circulation and can be used to promote an inflationary monetary policy. As the supply of money rises, its relative value usually declines, leading to increased inflation. Inflation is influenced by a variety of factors, however, and the impact of monetary policy varies from situation to situation. The United States Federal Reserve followed a profoundly inflationary policy in response to the crisis of 2008, but other economic factors stemming from the crisis were also at work and greatly reduced the actual rate of inflation.
A modest rate of inflation, in the range of 1 to 3 percentage points per year, is generally considered ideal. Such a rate slightly promotes growth. More crucially, slow but steady inflation wards off deflation, which can lead to vastly decreased economic activity, as consumers avoid engaging in economic activity in order to gain the benefit of falling prices over time, a process that often causes further deflation and serious economic disruption.
Economic regulators may pursue an inflationary monetary policy more aggressively under some circumstances than others. Inflationary policies can be used to reduce the actual value of state debt. Much of the debt incurred by the United States during the Second World War, for instance, was never actually repaid but was reduced in real value by the gradual compound effects of inflation on the value of the debt. A similar policy may be used to adjust the value of a nation’s currency when that currency has been devalued to the point that it is no longer useful.
Governments under duress often rely on a riskier form of inflationary monetary policy. Faced by a shortage of revenue, these governments simply expand the currency supply, printing money or debasing metallic currency to produce more money. Governments can employ such a policy carefully to provide additional spending power over a short period, but overuse can lead to hyperinflation.
