How to Control Inflation?

Inflation is a sustained increase in the aggregate price levels. It refers to a state of rising prices and not a state of high prices. If there is an excess of aggregate demand in the economy over aggregate supply, the general price level will tend to increase, which leads to inflation. Now the question is How to Control Inflation?

Fiscal Measures

Fiscal measures to control inflation include taxation, government expenditure and public borrowings. The choice of fiscal measures for controlling inflation depends on the causes of excess demand as follows:

Government expenditure:

When excess demand is caused by the government expenditure more than
real output, the most effective measure is to cut down on public expenditure. A cut in public expenditure reduces not only the government’s demand for goods and services but also private consumption expenditure. Therefore, the excess demand decreases more than a given cut in public expenditure.

Taxation:

When excess demand is caused by private expenditure such as the expenditure by the households and firms, taxation of income is a more appropriate measure to control inflation. Taxation of income reduces disposable income. As consumer demand is a function of disposable income, consumer demand decreases because of taxation. Thus, a well-designed taxation policy reduces aggregate
demand and thereby brings inflation under control.

Public borrowing:

Borrowings by the government to fund budget deficits uses idle money lying with banks and financial institutions for productive functions by investing it. When the government borrows money
from the market, it reduces the purchasing power of the public.

Monetary Measures

Bank rate policy:

The increase in the bank rate increases
the cost of borrowing which reduces the borrowings of the commercial banks from the Central Bank. Consequently, the flow of money from the commercial banks to the public reduces. Therefore, inflation is controlled to the extent it is caused by bank credit.

Cash reserve ratio (CRR):

While controlling inflation, the Central Bank raises the CRR which reduces the lending capacity of commercial banks. Consequently, the flow of money from
commercial banks to the public decreases. In the process, it halts the rise in prices to the extent it is caused by bank credits to the public.

Open market operations:

While controlling inflation, the Central Bank sells government securities to the
public through banks. This results in the transfer of part of the bank deposits to the Central Bank account and reduces the credit creation capacity of commercial banks.

Other Measures to Control Inflation

Price Control:

When the government resorts to price control, a maximum retail price of goods and services is fixed. The primary objective is to prevent the price rise of scarce goods and to ration the use of the commodity. This measure is adopted to control hyperinflation.

Wage Control:

Wage control is used to combat inflation when wages tend to rise much faster than productivity. The government controls wage rise directly by imposing a ceiling on the wage incomes in both private and public sectors.

Increase in Output:

By increasing the level of output, the prices of essential consumer goods are
maintained at a low level. Also, the government initiates a liberal import policy to overcome the shortfall of goods in the market.

Meaning and Functions of Money

Follow us