Q.Discuss the monetary and fiscal measures used to control inflation.

Inflation can be checked by monetary measures (dearer and tighter credit by the central bank), fiscal measures (cutting government spending, raising taxes and borrowing to mop up excess money), and direct measures (raising output, price control, rationing and wage restraint).

Meaning

Inflation is a situation of a sustained and appreciable rise in the general level of prices, caused mainly by an excess of aggregate demand (money) over the available supply of goods. Its control calls for measures that reduce demand and increase supply.

Measures for Control of Inflation

1. Monetary Measures (by the central bank)

• Raising the bank rate — makes borrowing from the central bank costlier, so commercial banks raise their lending rates, credit contracts and demand falls.
• Open market operations — the central bank sells government securities to absorb excess money from the economy.
• Raising the cash reserve ratio (CRR) and statutory liquidity ratio (SLR) — reduces the lending capacity of commercial banks.
• Credit rationing and selective credit controls — restrict the amount and direction of bank credit.

2. Fiscal Measures (by the government)

• Reducing public expenditure — the government cuts unnecessary spending to reduce total demand.
• Increasing taxes — higher direct and indirect taxes reduce the purchasing power of the people.
• Public borrowing — borrowing from the public withdraws surplus money from circulation.
• Surplus budget — the government keeps revenue above expenditure so that excess money is mopped up.

3. Other / Direct Measures

• Increasing production — raising the output of goods, especially essential goods, to match demand.
• Price control and rationing — fixing maximum prices and distributing scarce goods fairly through the public distribution system. …

The measures to control inflation fall into three groups: monetary measures by the central bank that reduce the money supply and credit, fiscal measures by the government that reduce excess demand, and other direct measures such as raising output, price control and rationing.

Meaning

Inflation is a continuous rise in the general price level, which reduces the purchasing power of money. To check it, the excess of demand over supply must be removed, using the following measures.

1. Monetary measures (taken by the central bank)

• Raising the bank rate so that borrowing becomes dearer and credit contracts.
• Increasing the Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) to reduce the lending capacity of banks.
• Open-market operations: selling government securities to absorb money from the economy.
• Qualitative controls such as raising the margin requirement and regulating consumer credit.

2. Fiscal measures (taken by the government)

• Reducing public (government) expenditure to lower aggregate demand.
• Increasing taxes, especially direct taxes, to cut the disposable income and spending of the people.
• Public borrowing to mop up excess purchasing power from the public.
• Running a surplus budget rather than a deficit budget.

3. Other measures

• Increasing the production and supply of goods, especially essential goods. …