Measures To Control Inflation - INFLATION 6.1. Introduction

INFLATION 6.1. Introduction

6.9. Measures To Control Inflation

Inflation usually adversely affects helpless people and disturbs the social, political and economical equilibrium. Hence, it need to be controlled. However, control of inflation does not mean absolute price stability. Absolute price stability is not the objective of any nation. People expect economic growth with price stability. Price stability without growth does not achieve economic objective of a nation. So, prices should be allowed to rise within certain limits (say, 2 to 3 percent), but this should not rise to such an extent that it takes away all the benefits of economic growth.

Inflation can be controlled through an integrated set of measures which may be classified as monetary, fiscal and other measures.

6.9.1. Monetary Measures

Monetary policy is the policy of the central bank of a country. In India, we faced hyperinflation of 13.8% in 1966-67 due to the Pakistan war and the famine. In such situation, the government should control the money supply in the economy to control the rate of inflation. This can be achieved through quantitative and qualitative

(selective) control measures.

Quantitative credit control measures can be in the form of bank rate policy, open market operations and variable reserve ratio to influence the cost and availability of credit in an economy.

Depending on the rate of inflation, the central bank can vary the bank rate to control inflation. An increase in the bank rate automatically increases the interest rate and reduces the investment rate (as it becomes less attractive). Increase in the interest rate can also control excess demand by diverting the excess money into savings.

Through open market operation, government securities are bought and sold in the market. If the inflation rate is very high, the government will sell the securities in the open market to curb inflation in economy. By selling securities, the government tries to take away excess money from people, thus curbing excess demand in the economy.

Here again, curbing inflation through open market operations depends on the

attractiveness of the government securities. Of the various quantitative measures for controlling the money supply, the cash reserve ratio is the most effective monetary control measure. Based on the type of inflation the economy is facing, the central bank can raise the cash reserve ratio and curb the lending power of the bank. A high cash reserve ratio requirement will reduce the lending capability of banks.

The most common selective control measure is the regulation of consumer credit. Credit facilities can be curbed by raising down payment requirements or reducing the payment periods. Besides such selective credit control measures, the central bank can use

directives, moral persuasion, publicity, etc. to control monetary expansion in the economy.

The success of monetary measures depends mainly on the degree of credit control measures and the cooperation the central bank receives from commercial banks and other financial institutions.

6.9.2. Fiscal Measures

The aggregate demand of an economy depends mainly on the level of government expenditure. Government expenditure to a great extent influences the money supply in an economy, and therefore inflation in the economy. The fiscal measures for controlling inflation are public expenditure, taxation, public borrowing and debt.

Public expenditure

Increase in public expenditure contributes to inflation by increasing the disposable income of the public which in turn will increase the demand for goods and services.

Therefore, government can reduce inflation by reducing the public expenditure. Public expenditure has a multiplier effect on income, output and employment. Therefore, reduction in public expenditure will reduce inflationary pressures. But this anti-inflationary tool should be used with care. Reduction in developmental and defence expenditure can prove to be too costly to a country. Similarly, the projects that the government has already taken up should not be abandoned. Instead, the government should minimize nonessential expenditures.

Taxation

The amount of disposable income depends on the taxation policy of the government.

The imposition of direct or indirect taxes reduces the purchasing power of the people. It also generates revenue to the government. Anti-inflationary taxation should reduce that part of the disposable income which would otherwise have been spent on consumption.

Before introducing new taxes, the government should analyze how the tax burden will affect people. If the government increases the income tax and at the same time,

increases indirect taxes on necessities, burden of taxation will largely fall on the middle class. The rich and business classes will not bear the burden of taxation. Hence the government should impose higher taxes on luxury goods and increase excise duties on commodities that are consumed only by high income people. Indirect taxes, moreover, increase cost push inflation in the economy.

Public borrowing and debt

During inflationary periods, government can start special saving programs to take away the extra purchasing power which would otherwise increase pressure on demand.

Similarly, government can offer bonds to public at attractive interest coupon rates. If an appeal to voluntary saving does not yield the desired results, the government may resort to compulsory savings. But usually, compulsory savings are avoided during peace time.

6.10. Summary

Inflation is the rate of change in the overall price level of goods and services. Different types of inflation are: creeping, running, hyperinflation, and deflation.

There are two sources of inflation, demand pull and cost push inflation. Demand pull inflation is caused due to excessive demand for goods and services. When aggregate demand increases, the price level also simultaneously moves up. Cost push inflation results from an increase in the cost of factors of production or a decrease in the supply of goods with demand remaining the same.

Inflation is measured by the Wholesale Price Index and the Consumer Price Index. The wholesale price index is an indicator designed to measure the changes in the price levels of commodities that flow into the wholesale trade intermediaries. The consumer price index reflects the cost of living for a specific groups in the population. The CPI is measured on the basis of the change in retail prices of selected goods and services (essential goods) on which specific groups of consumers spend their money, based on their income.

Inflation affects an economy in the distribution of income and wealth, and production.

The Philips curve describes the inverse relationship between unemployment and the wage rate.

Inflation can be controlled by monetary, fiscal and other measures. Monetary measures include adjustments in money supply and bank rates, open market operations and changes in reserve ratios. Fiscal measures include control on public expenditure, taxation, public borrowing and debt. Other measure include price control and rationing, changes in wage policy, etc.

Test your Understanding Q.N.1. Define inflation.

Q.N.2. Explain the concept of Aggregate Demand and Aggregate Supply.

Q.N.3. What is demand-pull inflation?

Q.N.4. Describe measures to control inflation.

Notes

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CHAPTER 7

BUSINESS CYCLE AND UNEMPLOYMENT

Dans le document Td corrigé Macro Economics pdf (Page 76-81)