Effects of Inflation and Anti-Inflationary Measures

Inflation affects different groups and different parts of the economy unevenly.

• Effect on production — mild inflation can encourage producers to expand output, anticipating higher prices and profits; but high inflation, and certainly hyperinflation, discourages saving and investment, because the future value of money becomes unpredictable, which eventually hurts production instead of helping it.
• Effect on distribution of income — inflation redistributes real income away from people on relatively fixed incomes (pensioners, salaried employees, and creditors) towards those whose incomes rise along with prices (businessmen, traders, and debtors), since a debtor repays a loan in money that is worth less in real terms than the money originally borrowed.
• Effect on savings and investment — inflation discourages financial saving, because the real (inflation-adjusted) return on bank deposits and fixed-income instruments falls, often pushing households towards physical assets such as gold and real estate instead.
• Effect on the balance of payments — domestically produced goods become relatively more expensive than foreign goods, which can reduce exports and encourage imports, worsening the trade balance.
• Social effects — inflation hits the poor and those on fixed incomes hardest, since necessities take up a larger share of their spending, widening economic inequality and social discontent.

Remedies for inflation fall under three broad heads.

Monetary measures, carried out by the RBI, aim to reduce the money supply and the availability of bank credit — raising the repo rate, the CRR, and the SLR; selling government securities through open market operations; and tightening margin requirements on loans against sensitive commodities.

Fiscal measures, carried out by the government, aim to reduce aggregate demand directly — raising taxes to cut disposable income, reducing non-essential public expenditure, and cutting back deficit financing (borrowing to cover a budget gap through methods that expand the money supply). …