Control of Inflation
Authors: *Rajendra Jangid, Mahendra and Nemi Chand Meena
*Department of Agricultural Economics, S.K.N. Agriculture University
Jobner-303329, Jaipur, Rajasthan, India
Control of Inflation Since main factor for the emergence of inflation is excess of aggregate demand in relation to aggregate output at full employment, steps should be taken to reduce aggregate demand so as to equate it with full employment output in the economy.
Following measures may be adopted:
• Direct Measures
• Fiscal Measures
• Monetary Measures
• Enlarging Import Surpluses
• Fuller uilisation of productive capacity for raising aggregate supply.
1. Direct Measures/ Income Policies
A deliberate, organised and continuous government effort to persuade, or in extreme case requiring business workers and others to avoid, reduce, or delay increase which they might otherwise have made in prices, wages, rents, dividends or other form of money incomes.
• Compulsary Measures (Deferred payment schemes)
• Voluntary Measure which are ineffectie
But policy is opposed as it affects wages and salaries only why not rent, interest and profits and its against social justice
2. Monetary Policy
Monetary policy refers to the credit control measures adopted by the central bank of a country to influence:
a. to influence the level of aggregate demand for goods and services
b. to influence the trends in certain sectors of the economy.
Monetary policy operates through varying the cost and availability of credit which affect the demand for and the supply of credit in the economy, and the nature of economic activities.
Objective or Goals of Monetary Policy :
• Full Employment: keeps the value of money stable, eliminates cyclical fluctuations.
• Price stability: Brings economic stability, helps in reducing inequalities of income and wealth, secures social justice and promotes economic welfare
• Economic growth: it is measured by the increase in the amount of goods and services produced in a country.
• Balance of payments: This is because a deficit in the balance of payment leads to a sizeable outflow of gold
Instruments of Monetary Policy
• General (Quantitative) - Bank rate policy, open market operations, variable reserve ratio, statutory liquidity ratio affect the economy in general.
• Selective (Qualitative) - Minimum margins for lending against specific securities, ceilings on volume for credit, discriminatory rates of interest affect selective sectors and segments of the economy.
General Credit Controls: Bank Rate Policy
• The Bank rate is also known as the Discount Rate. It refers to the minimum rate at which the central bank provides financial accommodation to commercial banks in the discharge of its function as a lender of the last resort.
• The Bank rate policy affects both the cost and availability of credit. As the central bank is the lender of the last resort, a commercial bank which is loaned up can obtain financial accommodation from the central bank and re-lend to its customers.
• An increase in the Bank rate means an increase in the rate of interest charged by the central bank on its advances to commercial banks. This compels the commercial bank to raise the interest rate they charge on their loans and advances to their customers and in turn contraction in money supply and vice versa.
• The Bank rate currently is 6.25%.
General Credit Controls: Cash Reserve Ratio:
• Commercial banks maintain a certain percentage of their deposits in the form of balance with the Central Bank as the Cash Reserve Ratio. The Central Bank has the power to vary this reserve requirement e.g., If the reserve requirement is 10%, commercial banks can lend upto 90% of the total reserves.
• The RBI is empowered to vary the CRR between 3% and 15% of the total demand and time liabilities. Increase in the CRR decreases the money supply and vice versa.
• Presently the CRR is 4%
General Credit Controls: Open Market Operations:
• It refers to the purchase and sale by the Central Bank of a variety of assets, such as foreign exchange, gold, government securities and company shares. In India, however it refers to the purchase and sale of Government securities.
• By way of open market operations, the central bank either increases or decreases the money supply in the country. To increase the money supply, the Central bank buys securities from commercial banks and public and vice versa. Open market operations are used to provide seasonal finance to banks
General Credit Controls Statutory Liquidity Ratio:
Statutory Liquidity Ratio: All banks are required to maintain a minimum amount of liquid assets which shall not be less than a certain specified percentage of their demand and time liabilities.
Presently SLR is 20 %.
• Repo and Reverse Repo Rates are tools available in the hands of RBI to manage the liquidity in the system and to a certain extent influence market interest rates. It either injects liquidity into the market if the conditions are tight or sucks out liquidity if the liquidity is excess in the system through the Repo and Reverse Repo mechanism, besides a host of other measures.
• Through REPO rate RBI injects liquidity into the system i.e. it purchases the securities from the banks and lends money to them to ease their liquidity. The rate charged by it for lending money is the REPO rate. Therefore, Repo Rate is the rate at which the Central Bank pumps in short-term liquidity into the system. Presently it is 6%
• Reverse REPO rate is the opposite of REPO rate: When liquidity is excess in the system. RBI sucks it out by Reverse REPO by lending securities and taking out money from banks. Therefore, the Reverse Repo Rate is the rate at which banks park their short-term excess liquidity with the Central Bank. Presently it is 5.75%
Selective Credit Regulations
• This refers to regulation of credit for specific purposes or branches of economic activity. They relate to the distribution or direction of available credit policies.
The Banking Regulation Act empowers the RBI to give directions to banking companies, with regards to:
• Purposes for which advances may or may not be made.
• Margin to be maintained for secured advances
• Ceiling on the amounts of credit for certain purposes
• Discriminatory rates of interest charged on certain types of advances.
• Moral Suasion: In addition to the above mentioned methods of credit control, it may be noted that the use has also been made in this country of moral suasion wherein letters are issued to banks urging them to exercise control over credit in general or advances against particular commodities etc.
• Direct action: RBI may refuse to rediscount bills etc.
Monetary Policy in India
• Controlled Expansion (1951-72):
RBIs main concern during this period was to moderate the expansion of credit and money supply in such a way so as to legitimize needs of industry and trade and to curb the use for unproductive and speculative purposes.
• Tight Monetary Policy (1972-1991):
RBI tightened the monetary policy to curb inflation. Monetary policy is made in response to fiscal policies. In seventies and eighties, large fiscal deficits were incurred. Reserve Bank’s credit to the Government increased sharply which caused a rapid growth in money supply. Thus the monetary policy was to neutralize the inflationary effect
• Monetary Policy during reforms (1991 onwards):
As part of the economic reforms in 1991 it was decided to reduce the fiscal deficit. Until 1995 the focus of the policy was on ensuring price stability. Since 1995 the policy has been eased to accelerate economic growth. Since 1999, effects of policy were more encouraging
• Fiscal policy is a policy under which the government uses its expenditure and revenue programmes to produce desirable effects on national income, production and employment.
1. To achieve desirable price level:
The stability of general prices is necessary for economic stability. The maintenance of a desirable price level has good effects on production, employment and national income. Fiscal policy should be used to remove; fluctuations in price level so that ideal level is maintained.
2. To Achieve desirable consumption level:
A desirable consumption level is important for political, social and economic consideration. Consumption can be affected by expenditure and tax policies of the government. Fiscal policy should be used to increase welfare of the economy through consumption level.
3. To Achieve desirable employment level:
The efficient employment level is most important in determining the living standard of the people. It is necessary for political stability and for maximization of production.
4. To achieve desirable income distribution:
The distribution of income determines the type of economic activities the amount of savings. In this way, it is related to prices, consumption and employment. Income distribution should be equal to the most possible degree.
5. Increase in capital formation:
In under-developed countries deficiency of capital is the main reason for under-development. Large amounts are required for industry and economic development. Fiscal policy can divert resources and increase capital.
6. Degree of inflation:
In under-developed countries, a degree of inflation is required for economic development. After a limit, inflationary be used to get rid of this situation.
S.Subba Reddy, P.Raghu Ram, T.V.Neelakanta, I.Bhavani Devi. AGRICULTURAL ECONOMICS, OXFORD & IBH Publishing Co. Pvt. Ltd. New Delhi, Second Edition 2017.
About Author / Additional Info:
I am currently pursuing Ph.D. in Agricultural Economics from SKRAU, Bikaner.