CONTROL OF INFLATION

Inflation needs to be controlled in the very beginning, otherwise it completely ruins the economy, once it acquires the hyper inflation form. Various anti-inflationary measures are suggested to avoid or overcome disastrous consequences of inflation. Most of these measures aim at reducing aggregate demand for goods and services. These measures can be explained in three categories, namely, monetary measures, fiscal measures and other measures.

 1. Monetary Measures

Growth of inflation during the post Second War period revived the confidence in the potency of monetary policy, though it proved to be ineffective by Keynes to control depression. Monetary policy is the policy of the central bank of the country, which is the supreme monetary authority. Monetary measures attempt to regulate the money supply in an economy. To check inflation, increase in the volume of currency should be avoided. If there is abundant black money, currency of higher denominations should be demonetized. New currency notes can also be issued in exchange of old currency notes.

Bank deposits which enable credit creation form large share of money supply. Thus, the main concern of monetary measures should be to regulate the bank credit. Central bank uses various quantitative and qualitative (selective) control measures for this purpose. Quantitative control measures such as bank rate policy, open market operations and variable reserve requirements influence the cost and availability of credit.

The central bank by raising the bank rate can easily push up the market) rates of interest and makes investment less attractive. Inflationary rise in prices is arrested by choking off the excess demand. The bank rate policy is effective, if banks do not have an easy access to other sources of funds. Under open market operations, through sale of government securities, money supply is reduced. This measure is superior to the bank rate policy, as it directly affects the money supply. However, its success to control credit and hence inflation depends upon the attractiveness of these securities and the existence of organized money market. Variable reserve requirements is the most effective measure to check inflation, but it is not very often used due to its harsh effects. By raising the cash reserve ratio, central bank can reduce the amount of credit which banks can create.

 Among selective control measures, the regulation of consumer credit has become very common with the rise of consumerism. During inflation, consumer credit facilities are curtailed by raising the down payments and reducing the payment period on selective basis. Central bank may also fix higher margin requirements for loans according to the purposes. Higher are the margin requirements, lower will be the amounts of loans that the borrowers can obtain from the bank. These selective control measures, besides directives, moral suasion, publicity, direct action, etc., may be used to limit the undue monetary expansion.

The effectiveness of the monetary measures depends upon the degree of control exercised by the central bank and the extent of cooperation extended by the commercial banks and other constituents of the money market. In a developing country like India, most of these factors are lacking. Hence monetary policy will be of little value here. Further, when inflation is due to expansion of printed currency (to finance war or development plans), fiscal measures will be more useful to which we now turn.

 2. Fiscal Measures

As government expenditure has become an important portion of the aggregate expenditure in almost every economy of the world, the government can significantly affect the money supply and hence inflation. Monetary policy, when supplemented by fiscal policy will become more effective. The following anti-inflationary fiscal measures can be used to mop up the excessive purchasing power in the economy.

(a) Public Expenditure

To control price rise, the government can reduce its expenditure. This will reduce public money from the market and hence the demand for goods and services. Reduction in government expenditure as an anti-inflationary weapon should be used with care. It is almost suicidal to curtail defence or development expenditure of the government. Further, it is of no use to give up the schemes under various plans, that the government has already taken up. Thus, the government must keep the non-essential expenditure to the minimum. This will also put a check on private expending, which depend upon government expenditure.

(b) Taxation

Taxes determine the volume of disposable income in the hands of the people. Imposition of new taxes and raising the rates of taxes, on one hand reduces the purchasing power of the people. On the other hand, it generates resources to the government for combating inflation. Anti-inflationary taxation should, thus, aim at reducing the disposable income, that otherwise would be spent on consumption. Tax revenue realized by the government should be used to maintain essential expenditure. However, the rates of taxes should not be so high as to discourage saving, investment and production. Rather, the tax system should provide larger incentives to those who save, invest and produce. Further, to bring more tax revenue, the government should penalize the tax evaders by imposing heavy fines.

The government should give up deficit financing and instead have surplus budgets by collecting more tax revenues by a fine combination of direct and indirect taxes. Direct taxes like income tax, wealth tax, expenditures tax, etc., decline the disposable income and exert pressure on demand. Indirect taxes may also produce similar effects with an extra advantage of wide coverage. However, indirect taxes fall heavily on fixed income earners, who are already hit by the inflation. This discriminating effects can be corrected by imposing heavy excise duties and other similar taxes on luxury commodities, which are consumed by imposing heavy by the high income groups in the economy. However, indirect taxes are not suitable as these add to the cost push inflation by raising the prices of goods.

(c) Public Borrowing and Debt

The main purpose of public borrowing, like tax is to take away from public, excessive purchasing power, which if left free, would exert an upward pressure on the demand. If voluntary borrowing does not yield the desired results, the government may resort to compulsory borrowing. Forced loans, a variant of compulsory savings have been tried in Norway, Belgium and Holland. Compulsory provident fund cum-pension schemes, etc., may be introduced compulsorily. The government can also float public loans carrying high rates of interest, start saving scheme for long periods with prize money or lottery.

The government should avoid paying back any of its previous loans during inflation to prevent an increase in the circulation of money. Further, if possible, the payment of part of the salary to the employees he deferred to reduce current purchasing power of people. Deferred purchasing power can be released, when inflation comes to an end or there is an expectation of recession in the economy. Similarly, pay revision arrears may be transferred to the provident fund accounts, rather making cash payments of the same during inflation. Compulsory savings and deferred payments are normally avoided during peace time.

For more help in Control of Inflation please click the button below to submit your homework assignment.