Description
It describes Methods of control of Inflation, Monetary Policy, Raising bank rates, Open market operations, Variable reserve ratio, Fiscal measures, Direct measures of control
Methods of control of Inflation A high inflation rate is undesirable because it has negative consequences. However, the remedy for such inflation depends on the cause. Therefore, government must diagnose its causes before implementing policies. Monetary Policy Inflation is primarily a monetary phenomenon. Hence, the most logical solution to check inflation is to check the flow of money supply by devising appropriate monetary policy and carefully implementing such measures. To control inflation, it is necessary to control total expenditures because under conditions of full employment, increase in total expenditures will be reflected in a general rise in prices, that is, inflation. Monetary policy is used to control inflation and is based on the assumption that a rise in prices is due to excess of monetary demand for goods and services by the consumers/households e because easy bank credit is available to them. Monetary policy, thus, pertains to banking and credit availability of loans to firms and households, interest rates, public debt and its management, and the monetary standard. Monetary management is aimed at the commercial banking systems, and through this action, its effects are primarily felt in the economy as a whole. By directly affecting the volume of cash reserves of the banks, can regulate the supply of money and credit in the economy, thereby influencing the structure of interest rates and the availability of credit. Both these, factors affect the components of aggregate demand and the flow of expenditure in the economy. The central bank’s monetary management methods, the devices for decreasing or increasing the supply of money and credit for monetary stability is called monetary policy. Central banks generally use the three quantitative measures to control the volume of credit in an economy, namely: 1. Raising bank rates 2. Open market operations 3. Variable reserve ratio
However, there are various limitations on the effective working of the quantitative measures of credit control adapted by the central banks and, to that extent, monetary measures to control inflation are weakened. In fact, in controlling inflation moderate monetary measures, by themselves, are relatively ineffective. On the other hand, drastic monetary measures are not good for the economic system because they may easily send the economy into a decline. In a developing economy there is always an increasing need for credit. Growth requires credit expansion but to check inflation, there is need to contract credit. In such a encounter, the best course is to resort to credit control, restricting the flow of credit into the unproductive, inflationinfected sectors and speculative activities, and diversifying the flow of credit towards the most desirable needs of productive and growth-inducing sector. It should be noted that the impression that the rate of spending can be controlled rigorously by the contraction of credit or money supply is wrong in the context of modern economic societies. In modern community, tangible, wealth is typically represented by claims in the form of securities, bonds, etc., or near moneys, as they are called. Such near moneys are highly liquid assets, and they are very close to being money. They increase the general liquidity of the economy. In these circumstances, it is not so simple to control the rate of spending or total outlays merely by controlling the quantity of money. Thus, there is no immediate and direct relationship between money supply and the price level, as is normally conceived by the traditional quantity theories.
When there is inflation in an economy, monetary restraints can, in conjunction with other measures, play a useful role in controlling inflation. Fiscal measures Fiscal policy is another type of budgetary policy in relation to taxation, public borrowing and public expenditure. To curve the effects of inflation and changes in the total expenditure, fiscal measures would have to be implemented which involves an increase in taxation and decrease in government spending. During inflationary periods the government is supposed to counteract an increase in private spending. It can be cleared noted that during a period of full employment inflation, the aggregate demand in relation to the limited supply of goods and services is reduced to the extent that government expenditures are shortened.
Along with public expenditure, governments must simultaneously increase taxes that would effectively reduce private expenditure, in an effect to minimise inflationary pressures. It is known that when more taxes are imposed, the size of the disposable income diminishes, also the magnitude of the inflationary gap in regards to the availability of the supply of goods and services. In some instances, tax policy has been directed towards restricting demand without restricting level of production. For example, excise duties or sales tax on various commodities may take away the buying power from the consumer goods market without discouraging the level of production. However, some economists point out that this is not a correct way of combating inflation because it may lead to a regressive status within the economy. As a result, this may lead to a further rise in prices of goods and services, and inflation can spread from one sector of the economy to another and from one type of goods and services to another. Therefore, a reduction in public expenditure, and an increase in taxes produces a cash surplus in the budget. Keynes, however, suggested a programme of compulsory savings, such as deferred pay as an anti-inflationary measure. Deferred pay indicates that the consumer defers a part of his or her wages by buying savings bonds (which, of course, isa sort of public borrowing), which are redeemable after a particular period of time, this is sometimes called forced savings. Additionally, private savings have a strong disinflationary effect on the economy and an increase in these is an important measure for controlling inflation. Government policy should therefore, include devices for increasing savings. A strong savings drive reduces the spendable income of the consumers, without any harmful effects of any kind that are associated with higher taxation. Furthermore, the effects of a large deficit budget, which is mainly responsible for inflation, can be partially offset by covering the deficit through public borrowings. It should be noted that it is only government borrowing from non-bank lenders that has a disinflationary effect. In addition, public debt may be managed in such a way that the supply of money in the country may be controlled. The government should avoid paying back any of its past loans during inflationary periods, in order to prevent an increase in the circulation of money. Anti-
inflationary debt management also includes cancellation of public debt held by the central bank out of a budgetary surplus. Fiscal policy by itself may not be very effective in combating inflation; therefore a combination of fiscal and monetary tools can work together in achieving the desired outcome.
Direct measures of control Direct controls refer to the regulatory measures undertaken to convert an open inflation into a repressed one. Such regulatory measures involve the use of direct control on prices and rationing of scarce goods. The function of price control is a fix a legal ceiling, beyond which prices of particular goods may not increase. When ceiling prices are fixed and enforced, it means prices are not allowed to rise further and so, inflation is suppressed. Under price control, producers cannot raise the price beyond a specified level, even though there may be a pressure of excessive demand forcing it up. For example, during wartimes, price control was used to suppress inflation. In times of the severe scarcity of certain goods, particularly, food grains, government may In times of the severe scarcity of certain goods, particularly, food grains, government may have to enforce rationing, along with price control. The main function of rationing is to divert consumption from those commodities whose supply needs to be restricted for some special reasons; such as, to make the commodity more available to a larger number of households. Therefore, rationing becomes essential when necessities, such as food grains, are relatively scarce. Rationing has the effect of limiting the variety of quantity of goods available for the good cause of price stability and distributive impartiality. However, according to Keynes, “rationing involves a great deal of waste, both of resources and of employment.” Another control measure that was suggested is the control of wages as it often becomes necessary in order to stop a wage-price spiral. During galloping inflation, it may be necessary to apply a wage-profit freeze. Ceilings on wages and profits keep down disposable income and, therefore the total effective demand for goods and services.
On the other hand, restrictions on imports may also help to increase supplies of essential commodities and ease the inflationary pressure. However, this is possible only to a limited extent, depending upon the balance of payments situation. Similarly, exports may also be reduced in an effort to increase the availability of the domestic supply of essential commodities so that inflation is eased. But a country with a deficit balance of payments cannot dare to cut exports and increase imports, because the remedy will be worse than the disease itself. In overpopulated countries like India, it is also essential to check the growth of the population through an effective family planning programme, because this will help in reducing the increasing pressure on the general demand for goods and services. Again, the supply of real goods should be increased by producing more. Without increasing production, inflation just cannot be controlled. Some economists have even suggested indexing in order to minimise certain ill-effects o f inflation. Indexing refers to monetary corrections through periodic adjustments in money incomes of the people and in the values of financial assets such as savings deposits, which are held by them in relation to the degrees of price rise. Basically, if the annual price were to rise to 20%, the money incomes and values of financial assets are enhanced by 20%, under the system of indexing. Indexing also saves the government from public wrath due to severe inflation persisting over a long period. Critics, however, do not favour indexing, as it does not cure inflation but rather it encourages living with inflation. Therefore, it is a highly discretionary method. In general, monetary and fiscal controls may be used to repress excess demand but direct controls can be more useful when they are applied to specific scarcity areas. As a result, anti-inflationary policies should involve varied programmes and cannot exclusively depend on a particular type of measure only.
doc_802782643.docx
It describes Methods of control of Inflation, Monetary Policy, Raising bank rates, Open market operations, Variable reserve ratio, Fiscal measures, Direct measures of control
Methods of control of Inflation A high inflation rate is undesirable because it has negative consequences. However, the remedy for such inflation depends on the cause. Therefore, government must diagnose its causes before implementing policies. Monetary Policy Inflation is primarily a monetary phenomenon. Hence, the most logical solution to check inflation is to check the flow of money supply by devising appropriate monetary policy and carefully implementing such measures. To control inflation, it is necessary to control total expenditures because under conditions of full employment, increase in total expenditures will be reflected in a general rise in prices, that is, inflation. Monetary policy is used to control inflation and is based on the assumption that a rise in prices is due to excess of monetary demand for goods and services by the consumers/households e because easy bank credit is available to them. Monetary policy, thus, pertains to banking and credit availability of loans to firms and households, interest rates, public debt and its management, and the monetary standard. Monetary management is aimed at the commercial banking systems, and through this action, its effects are primarily felt in the economy as a whole. By directly affecting the volume of cash reserves of the banks, can regulate the supply of money and credit in the economy, thereby influencing the structure of interest rates and the availability of credit. Both these, factors affect the components of aggregate demand and the flow of expenditure in the economy. The central bank’s monetary management methods, the devices for decreasing or increasing the supply of money and credit for monetary stability is called monetary policy. Central banks generally use the three quantitative measures to control the volume of credit in an economy, namely: 1. Raising bank rates 2. Open market operations 3. Variable reserve ratio
However, there are various limitations on the effective working of the quantitative measures of credit control adapted by the central banks and, to that extent, monetary measures to control inflation are weakened. In fact, in controlling inflation moderate monetary measures, by themselves, are relatively ineffective. On the other hand, drastic monetary measures are not good for the economic system because they may easily send the economy into a decline. In a developing economy there is always an increasing need for credit. Growth requires credit expansion but to check inflation, there is need to contract credit. In such a encounter, the best course is to resort to credit control, restricting the flow of credit into the unproductive, inflationinfected sectors and speculative activities, and diversifying the flow of credit towards the most desirable needs of productive and growth-inducing sector. It should be noted that the impression that the rate of spending can be controlled rigorously by the contraction of credit or money supply is wrong in the context of modern economic societies. In modern community, tangible, wealth is typically represented by claims in the form of securities, bonds, etc., or near moneys, as they are called. Such near moneys are highly liquid assets, and they are very close to being money. They increase the general liquidity of the economy. In these circumstances, it is not so simple to control the rate of spending or total outlays merely by controlling the quantity of money. Thus, there is no immediate and direct relationship between money supply and the price level, as is normally conceived by the traditional quantity theories.
When there is inflation in an economy, monetary restraints can, in conjunction with other measures, play a useful role in controlling inflation. Fiscal measures Fiscal policy is another type of budgetary policy in relation to taxation, public borrowing and public expenditure. To curve the effects of inflation and changes in the total expenditure, fiscal measures would have to be implemented which involves an increase in taxation and decrease in government spending. During inflationary periods the government is supposed to counteract an increase in private spending. It can be cleared noted that during a period of full employment inflation, the aggregate demand in relation to the limited supply of goods and services is reduced to the extent that government expenditures are shortened.
Along with public expenditure, governments must simultaneously increase taxes that would effectively reduce private expenditure, in an effect to minimise inflationary pressures. It is known that when more taxes are imposed, the size of the disposable income diminishes, also the magnitude of the inflationary gap in regards to the availability of the supply of goods and services. In some instances, tax policy has been directed towards restricting demand without restricting level of production. For example, excise duties or sales tax on various commodities may take away the buying power from the consumer goods market without discouraging the level of production. However, some economists point out that this is not a correct way of combating inflation because it may lead to a regressive status within the economy. As a result, this may lead to a further rise in prices of goods and services, and inflation can spread from one sector of the economy to another and from one type of goods and services to another. Therefore, a reduction in public expenditure, and an increase in taxes produces a cash surplus in the budget. Keynes, however, suggested a programme of compulsory savings, such as deferred pay as an anti-inflationary measure. Deferred pay indicates that the consumer defers a part of his or her wages by buying savings bonds (which, of course, isa sort of public borrowing), which are redeemable after a particular period of time, this is sometimes called forced savings. Additionally, private savings have a strong disinflationary effect on the economy and an increase in these is an important measure for controlling inflation. Government policy should therefore, include devices for increasing savings. A strong savings drive reduces the spendable income of the consumers, without any harmful effects of any kind that are associated with higher taxation. Furthermore, the effects of a large deficit budget, which is mainly responsible for inflation, can be partially offset by covering the deficit through public borrowings. It should be noted that it is only government borrowing from non-bank lenders that has a disinflationary effect. In addition, public debt may be managed in such a way that the supply of money in the country may be controlled. The government should avoid paying back any of its past loans during inflationary periods, in order to prevent an increase in the circulation of money. Anti-
inflationary debt management also includes cancellation of public debt held by the central bank out of a budgetary surplus. Fiscal policy by itself may not be very effective in combating inflation; therefore a combination of fiscal and monetary tools can work together in achieving the desired outcome.
Direct measures of control Direct controls refer to the regulatory measures undertaken to convert an open inflation into a repressed one. Such regulatory measures involve the use of direct control on prices and rationing of scarce goods. The function of price control is a fix a legal ceiling, beyond which prices of particular goods may not increase. When ceiling prices are fixed and enforced, it means prices are not allowed to rise further and so, inflation is suppressed. Under price control, producers cannot raise the price beyond a specified level, even though there may be a pressure of excessive demand forcing it up. For example, during wartimes, price control was used to suppress inflation. In times of the severe scarcity of certain goods, particularly, food grains, government may In times of the severe scarcity of certain goods, particularly, food grains, government may have to enforce rationing, along with price control. The main function of rationing is to divert consumption from those commodities whose supply needs to be restricted for some special reasons; such as, to make the commodity more available to a larger number of households. Therefore, rationing becomes essential when necessities, such as food grains, are relatively scarce. Rationing has the effect of limiting the variety of quantity of goods available for the good cause of price stability and distributive impartiality. However, according to Keynes, “rationing involves a great deal of waste, both of resources and of employment.” Another control measure that was suggested is the control of wages as it often becomes necessary in order to stop a wage-price spiral. During galloping inflation, it may be necessary to apply a wage-profit freeze. Ceilings on wages and profits keep down disposable income and, therefore the total effective demand for goods and services.
On the other hand, restrictions on imports may also help to increase supplies of essential commodities and ease the inflationary pressure. However, this is possible only to a limited extent, depending upon the balance of payments situation. Similarly, exports may also be reduced in an effort to increase the availability of the domestic supply of essential commodities so that inflation is eased. But a country with a deficit balance of payments cannot dare to cut exports and increase imports, because the remedy will be worse than the disease itself. In overpopulated countries like India, it is also essential to check the growth of the population through an effective family planning programme, because this will help in reducing the increasing pressure on the general demand for goods and services. Again, the supply of real goods should be increased by producing more. Without increasing production, inflation just cannot be controlled. Some economists have even suggested indexing in order to minimise certain ill-effects o f inflation. Indexing refers to monetary corrections through periodic adjustments in money incomes of the people and in the values of financial assets such as savings deposits, which are held by them in relation to the degrees of price rise. Basically, if the annual price were to rise to 20%, the money incomes and values of financial assets are enhanced by 20%, under the system of indexing. Indexing also saves the government from public wrath due to severe inflation persisting over a long period. Critics, however, do not favour indexing, as it does not cure inflation but rather it encourages living with inflation. Therefore, it is a highly discretionary method. In general, monetary and fiscal controls may be used to repress excess demand but direct controls can be more useful when they are applied to specific scarcity areas. As a result, anti-inflationary policies should involve varied programmes and cannot exclusively depend on a particular type of measure only.
doc_802782643.docx