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Money

Control Of Inflation

For any economy, inflation is a complex phenomenon. While moderate inflation is usually good for an economy, if it goes beyond it, then it can cause a disastrous situation for the economy. In this article, we will look at the fiscal policy and monetary measures to control inflation that the Government undertakes.

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Measures to Control Inflation

The government takes different measures to control inflation of different types as explained below:

Demand Pull Inflation Control

In order to control the demand-pull inflation, the Government undertakes some monetary measures and incorporates certain changes to the fiscal policy.

measures to control inflation

                                                                                                                                                          Source: Pixabay

Monetary Measures

One of the commonly used measures to control inflation is controlling the money supply in the economy. If the Government decreases the supply of money, then the demand will fall, leading to a fall in prices.

Therefore, the Government may decide to withdraw certain paper notes and/or coins from circulation. This decreases the money supply.

It is important to note that a major portion of the money supply lies with banks in the form of deposits or bank credit.

Therefore, by reducing the bank’s rate of lending (amount of money offered as credit), the Government can considerably reduce the supply of money in the economy.

Learn more about Indian Economy and GDP in more detail here.

In order to do so, the Central Bank of a country (RBI in India) increases the bank rate and reserve requirements leading to a reduction in the lending activities of banks.

Further, the Central Bank also starts issuing Government securities to commercial banks. Therefore, these banks spent a significant portion of their money on purchasing these securities and reduce the credit supply to the general public.

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Fiscal Policy Measures to Control Inflation

Apart from the monetary measures, the Government also uses fiscal measures to control inflation. A country’s fiscal policy has two essential components – Government revenue and expenditure.

Therefore, the Government can change the tax rates to increase its revenue or manage its expenditure better.

Typically, when the aggregate demand exceeds the aggregate supply, an inflationary gap arises. Therefore, the Government can take these fiscal measures to control inflation:

  1. Take steps to decrease the overall Government expenditure and transfer payments
  2. Increase the rate of taxes causing individuals to decrease their total expenditure, leading to a decrease in demand and a drop in the money supply in the economy.

The government can also use a combination of the two to obtain a reasonable control over inflation.

Cost-Push Inflation Control

In order to control cost-push inflation, the Government uses direct control measures. These include steps like freezing the wages of workers, putting upper limits on the prices of important inputs like electricity, coal, steel, etc.

While these steps can control the extent of inflation, it is not a good ploy for the long-term. At the end of the day, identifying the cause of inflation is the best way to control it.

Some other measures to control inflation

These are:

  • Increasing imports to augment the supplies of commodities in the domestic market
  • Increasing domestic production, etc.

Solved Question

Q1. What are some primary measures that the government takes to control inflation?

Answer: Primarily, the government uses monetary and fiscal measures to control inflation. Under monetary measures, it takes various steps to control the supply of money in the economy which invariably leads to a decrease in demand and thus, control over inflation. Under fiscal measures, the government tries to decrease its expenditure and increase its revenue.

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