Monetary and Fiscal policy are often targeted to effect inflation. Fiscal policy can cause an increase in government deficit, which will eventually lead to inflation. This causes the interest rate to increase and as this occurs more people will be willing to supply money in the form of savings. The only way for the money supply to return to equilibrium is for prices to increase, or inflation. Monetary Policy can also cause inflation.
Government tries to control inflation through monetary policy.
It is the Fed s job to try to keep inflation at low levels. It uses the tools discussed yesterday to do this. That means our income is worth less and we cannot buy the same amount as we used to. This is a very simplified example just to show you how inflation reduces buying power. Many companies offer a cost of living wage increase every year.