Control of Inflation: Measures and Economic Impact

“Excess of anything isn’t healthy” this phrase rightly describes the necessity of controlling inflation. When a country faces acute inflation, there is a high-interest rate and thus people cannot take up economic and costly projects thus eventually a whole set of people suffer from inflation. 

In this context we will learn what are the dominating factors that lead to this situation, what are the controlling techniques of inflation, and how does the RBI or the government of India maintain the inflation rate in India.

Monetary Policy to Curb Inflation

Inflation can be controlled by a contractionary monetary policy is one common method of managing inflation. A contractionary policy aims to reduce the supply of money within an economy by lowering the prices of bonds and rising interest rates. Thus, consumption falls, prices fall and inflation slows down.

A contractionary monetary policy is one common method of managing inflation. A contractionary policy aims to reduce the supply of money within an economy by lowering the prices of bonds and rising interest rates. Thus, consumption falls, prices fall and inflation slows down.

Methods to Control Inflation

The Central Bank and/or the government normally monitor inflation. Monetary policy is the key policy employed (changing interest rates). There are however several instruments to manage inflation in theory, including:

• Monetary Policy: Higher interest rates decrease the economy's demand, resulting in lower economic growth and lower inflation.

• Money supply management claims that there is a near correlation between money supply and inflation, so inflation can be regulated by regulating the money supply.

• Supply-side policies are policies designed to boost the economy's productivity and efficiency, placing downward pressure on long-term costs.

• Fiscal Policy: A higher rate of income tax could reduce spending, demand, and inflationary pressures through fiscal policy.

• Price limits may, in principle, help alleviate inflationary pressures by attempting to regulate wages. Nonetheless, apart from the 1970s, it was scarcely used.

What are the Measures to Check Inflation?

Inflation is an economic phenomenon that is used year after year to characterize rising prices for goods and services. This caused the consumer's buying power to decline because the rate of wage and income growth does not keep up with the rate of inflation.

Inflation management is not an easy mission, however. The rise in prices is due to several factors, such as aggregate demand, increased cash supply, etc. We need a lot of steps working in tandem to contain inflation.

Fiscal Measure to Control Inflation

Government spending, public borrowing, and taxes comprise the Fiscal Policies to Combat Inflation. The Keynesian economists often referred to as "Fiscal," argue that due to an excess of aggregate demand over aggregate supply, demand-pull inflation is induced.  Owing to spending by individuals, companies, and the government, aggregate demand rises (usually excessive spending by the government). This rise in demand due to the government or household spending can be effectively regulated by fiscal policies. Fiscal policy and fiscal initiatives are thus effective weapons of demand-pull inflation management.

If the key trigger behind demand-pull inflation is government spending, then it can be regulated by reducing public expenditure. The public demand for goods and services declines with a decline in public spending, along with a decrease in private income and consumption expenditure. In cases where demand increases due to an increase in private spending, the most effective way to manage inflation is by taxing profits. The taxation of private income decreases the disposable income in question, and also reduces consumer spending. This has the effect of reducing aggregate demand.

In the event of a very high persistent inflation rate, both such steps may be taken simultaneously by the government to contain inflation. In the case of a decrease in public spending, the rate of taxes on private income is increased to keep demand under control. This form of policy of concurrently using both measures is called the "Surplus Budgeting Policy," which notes that "the government should spend less than tax revenue".

Monetary Measures to Control Inflation

Monetary interventions are aimed at reducing revenue from money.

(a) Management of Credit:

Monetary policy is one of the essential monetary interventions. A variety of strategies are employed by the country's central bank to regulate the quantity and quality of credit. To that end, bank rates are raised, securities are sold on the open market, the reserve ratio is raised and a range of selective credit management steps are taken, such as raising margin thresholds and controlling consumer credit. When inflation is due to cost-push variables, monetary policy will not be effective in managing inflation. Due to demand-pull variables, monetary policy can only be effective in managing inflation.

(b) Currency Demonetisation:

One of the monetary steps is to demonetize higher-denomination currencies. Such a step is typically taken when the country has a surplus of black currency.

(c) New Currency Issuance:

The problem of a new currency in place of the old currency is the most drastic monetary measure. Under this process, one new note is exchanged for several old currency notes. Likewise, the value of bank deposits is set accordingly. Such a measure is introduced when the issue of notes is excessive and hyperinflation occurs in the region. It is a measure that is very successful. But it is wrong because it affects the tiny depositors the most.