19. Measures to control inflation and recession

Objectives:

After studying this lesson, you will be able to understand,

The important measures to control inflation

Monetary measures to control inflation

Fiscal measures to control inflation

Other measures to control inflation

19.1 Introduction

19.2 Monetary Measures

19.2.1 Increased Discount Rates

19.2.2 Sale of Government Securities

19.2.3 Higher Reserve Requirement

19.2.4 Consumer Credit Control

19.2.5 Higher Margin Requirements

19.3 Fiscal Measures:

19.3.1 Government Expenditure

19.3.2 Taxation

19.3.3 Public Borrowing

19.3.4 Debt Management

19.3.5 Over valuation

19.4 Other Measures

19.4.1 Expansion of Output

19.4.2 Wage Policy

19.4.3 Price Control and Rationing

19.5 Summary

19.6 Check your progress

19.7 Key concepts

19.8 Self Assessment questions

19.9 Answers to check your progress

19.10 Suggested Readings

19.1 Introduction:

In an earlier lesson, we discussed the different causes of inflation and effects of inflation

in an economy. We identified broadly two important causes result in inflation; they are

Excess demand and Excess supply of money. Similarly, recognized two discernible

effects, they are effects on production and on distribution. The above discussion thus

highlights the necessity of quick and prompt and effective action on the part of the

government to check and control the inflationary boom before it is too late, failing which

it shall soon degenerate into a slump accompanied by mass un-employment and distress.

Therefore, here in this lesson, we learn about the various measures through which how do

we control inflation to arrest ill effects on an economy

There are three way outs to check and control inflationary boom, they are:

Monetary Measures

Fiscal Measures

Other Measures

19.2 Monetary Measures:

Monetary measures are adopted by the central bank to control inflation than in curbing a

depression.

19.2.1 Increased Discount Rates:

To control inflation, central bank increases the rediscount rates. An increase in

rediscount rate increases the cost of borrowing funds for business and consumer spending

and result in a fall in the intensity of inflationary pressures in the economy.

19.2.2 Sale of Government Securities:

Another method to check the inflationary boom is to resort to sales of government

securities to the public by central bank. As the buying public purchases and pays for these

government securities, the commercial banks’ reserves with the central bank are

correspondingly reduced and they are obliged to adopt a restrictionist credit policy in

relation to business requirements. This process helps in creating tight money conditions

in the market, and thus arresting the further growth of the inflationary boom.

19.2.3 Higher Reserve Requirement

An increase in reserve requirements of the member-banks also serves as an anti-

inflationary weapon during inflation. It absorbs the excess reserves of the banking system

and thus prevents them from forming a basis for further credit expansion.

19.2.4 Consumer Credit Control

This is a device, which is generally introduced during inflation to curb excessive

spending on the part of consumers.

19.2.5 Higher Margin Requirements

Like the consumer credit control, this is also a method of selective credit control. The

central bank in its pursuance of an anti-inflation policy may raise the margin

requirements to higher levels.

19.3 Fiscal Measures:

Fiscal policy is now recognized as an important instrument to tackle an inflationary

situation. The major anti-inflationary fiscal measures are the following:

19.3.1 Government Expenditure

During inflation, as is well known, effective demand increases far too much due to

unregulated private spending. The increased private expenditure presses heavily against

the limited supply of goods and services available in the market. To counteract increased

private spending, the government should, at such a time, reduce its own expenditure to

the minimum extent possible to help limit the aggregate demand.

19.3.2 Taxation

Taxation acquires increased importance as an anti-inflationary weapon during an

inflationary boom. The problem during inflation is to reduce the size of disposable

income in the hands of the general public in view of the limited supply of goods and

services in the market. It is therefore, necessary to take away the excess purchasing

power from the public in the form of taxes

19.3.3 Public Borrowing

Public borrowing is another anti-inflation weapon, which is often utilized to contain

inflationary pressures in the economy. The object of public borrowing is to take away

from the public excess purchasing power, which, if left free, would surely exert an

upward pressure on the price level in view of the limited supplies of goods and services

in the economy. According to this plan, a certain percentage of the wages or salaries is

compulsorily deducted in exchange for savings bonds, which result in blocking

purchasing power for a definite period so as to control inflation.

19.3.4 Debt Management

The existing public debt should be mange in such a manner as to reduce the existing

money supply and prevent rather credit expansion. Anti-inflation debt management

usually requires the retirement or repayment of bank held debt out of a budgetary surplus.

The idea is that the government out of a budgetary surplus would retry the government

securities held by commercial banks.

19.3.5 over valuation

An overvaluation of domestic currency in terms of foreign currencies will also serve as

an anti-inflationary measure in three ways. Firstly, it will discourage exports and

thereby result in an increased availability of goods and services in the domestic market.

Secondly, by encouraging imports from broad, it will add to the domestic stock of

goods and services and, thus, absorb the excessive purchasing power in an economy.

Thirdly, by cheapening the prices of those foreign materials, which enter domestic

production, it will help in checking an upward cost-price spiral.

19.4 Other Measures

Among the other anti-inflationary measures may be included such thins as, a) an

expansion of output, b) wage policy, and c) price control and rationing, they can be

used to supplement the monetary –fiscal measures undertaken to contain inflationary

pressures.

19.4.1 Expansion of Output

Increased production is the best antidote to inflation because, as pointed out above, the

inflationary gap arises partly due to the inadequacy of output. But it becomes rather

difficult to increase output at a time of inflation because of the full utilization of

resources. Therefore, steps should be taken to increase the output of those goods,

which seem to be extremely sensitive to inflationary pressures by shifting productive

resources from the less inflation sensitive goods.

19.4.2 Wage Policy

During an inflationary boom, wages cannot be left free to chase prices upward. They

have to be controlled so as to contain inflationary pressures in the economy.

19.4.3 Price Control and Rationing

Price control of essential consumer goods was resorted to on a fairly wide scale in

various countries of the world to fight inflation during and after the Second World

War. The object of price control is to lay down the upper limit beyond which the price

of a particular commodity would not be allowed to rise. To ensure the successful

functioning of price control, tow conditions shall have to be satisfied. Firstly, the

government should have under its control adequate stock of the commodity concerned.

Fixing the price without having adequate stock of its own will surely result in failure.

Secondly the demand for the concerned commodity should be controlled through

rationing, failing which, taking advantage of the fixed price, the richer sections shall be

able to buy a major portion of the available stocks.

19.5 Summary:

At the outset, in this lesson we discussed about the various measures to control inflation.

Among them important measures are: Monetary, fiscal and other measures. Monetary

measures are adopted by the central bank of the country and include such steps as an

increase in rediscount rates, sale of government securities in the open market, an increase

in the reserve ratios and adjustments in selective controls to arrest an inflationary credit

boom. Each of these steps has its own limitations, though it can be said that monetary

measures are more effective in checking inflation than in curbing a depression. Besides,

fiscal measures or policy is now recognized as an important instrument to tackle an

inflationary situation. The major among them are, increase in the public expenditure,

increase in taxation and also enhance the public borrowing to reduce inflationary

pressures on an economy. Other measures such as expansion of output, wage policy,

price control through rationing can be used to supplement the monetary – fiscal measures

under taken to contain inflationary pressures.

However, through all these anti-inflationary measures, government trying to control

inflationary pressures but each one of them has their limitations in their implementation.

Necessary care has to be taken by government in using them as a weapon to control

inflationary conditions in an economy.

19.6 Check your progress

State whether the following statements are true or false.

1. Sale of Government Securities in the open market is one of the weapons among

monetary measures.

2. Credit expansion can be curbed with low reserve requirements by RBI

3. The object of public borrowing is to enhance excess purchasing power in the

hands of the public.

4. Price rise can be controlled through rationing.

19.7 Key concepts

1 Rediscount rate

2. Anti-inflationary

3. Government Securities

4.Reserve Requirements

5. Margin Requirements

6. Debt Management

7. Overvaluation

8. Rationing

9. Essential commodities

10. Wage cut

19.8 Self Assessment questions

1. Explain the role Monetary measures in controlling inflation.

2. Enlist the important measures to control inflation

3. Explain how fiscal policy contain the inflation

4. Do you accept other measures can supplement both the monetary-fiscal measures in

controlling inflation

19.9 Answers to check your progress

1. True 2. False 3 False 4. True

19.10 Suggested Readings

Ackley Gardner: Macro economic theory

Ward R A: Monetary theory and policy

Rana & Verma: Macro economic analysis

Hajela TN: Monetary economics

Ghatak: Monetary economics in developing economies