There are three lines of action to check and contain an inflationary boom namely, Monetary Measures, Fiscal Measures and other Measures.
i) Monetary Policy Measures
Following are the monetary measures, which can be used to curb inflationary pressures:
1. Increased re-discount
To curb inflation, the Central Bank generally increases the re-discount rates. An increase in the re-discount rates leads to an increase in bank rates, because there is a definite relationship between the two. An increase in bank rates tends to discourage borrowing by businessmen from banks, resulting in a fall in the intensity of inflationary pressures in the economy. An increase in interest-rates consequent upon the increase in the bank rate will make savings attractive than before and induce people to spend less on consumer goods. But the increase in re-discount rates as a weapon to check an inflationary boom has its limitations tool. Firstly, if the bank rates do not rise with the rise in re-discount rates, there will be no decline in business borrowings, and hence, the inflationary pressures will continue, even though the re-discount rates have been raised. Secondly, the effectiveness of higher re-discount rates as an anti-inflationary weapon shall be considerably undermined if the commercial banks have an easy access to additional reserves.
2. Sales of government securities in the open market
Another method to check the inflationary boom is to resort to sale of government securities to the public by the central bank. As the buying public purchases and pays for those government securities, the commercial banks’ reserves with the central bank are correspondingly reduced and they are obliged to adopt a restriction credit policy in relation to business requirements. But the sale of government securities as an anti-inflationary weapon is also subject to limitations. Firstly, this policy may be rendered ineffective if the commercial banks are able to increase their reserves by selling their stocks of government securities to the central bank. Secondly, this policy may also be offset by increased borrowing from or by increased sales of treasury bills to the central banks of the commercial banks.
3. Higher reserve requirements
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. But this method is also subject to limitations. Firstly, if the commercial banks happen to have very large excess reserves, even the raising of the reserve requirements may not significantly curtail their power to create credit. Secondly, the ability of commercial banks to increase the reserves through sale of government securities may render higher reserve requirements ineffective to check credit expansion.
4. Consumer credit control
During an inflationary boom, facilities for installment buying are reduced to the minimum to curtail excessive spending on the part of the consumers. This is done (i) by raising the minimum initial payments on specified goods, (ii) by extending the application of consumer credit control to a large number of consumer goods, and (iii) by reducing the length of the payment period, etc.
5. Higher margin requirements
It is a method of selective credit control. The central bank is its pursuance of higher levels. The central bank in its pursuance of an anti-inflationary policy may raise the margin requirements of loans to higher levels. The higher the margin requirements, the lower the amount of loan that the borrower can obtain from the bank. Thus, higher margin requirements have the effect of checking undue monetary expansion.
ii) Fiscal Policy Measures
The major anti-inflationary fiscal measures are the following:
1. Government expenditure
To counteract increased private spending at a time of inflation, the government should, at such a time, reduce its own expenditure to the minimum extent possible to help limit the aggregate demand. As against this, it may, however, be said that it is not so easy to reduce government expenditure particularly during the war period. Secondly, any drastic cut in government expenditure to cure inflation may actually land the economy in a slump.
2. Taxation
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. The rates of existing taxes should be steeply increased, while new taxes should be imposed on commodities so as to leave less money supply with the public to spend.
3. Public borrowing
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. If voluntary borrowing does not yield adequate results, it may become necessary to resort to compulsory borrowing from the public.
4. Debt management
The existing public debt should be managed in such a manner as to reduce the existing money supply and prevent further credit expansion. Anti-disciplinary debt management usually requires the repayment of bank-held debt out of a budgetary surplus. The idea is that the government securities held by commercial banks should be retired by the government out of the budgetary surplus. This would check the power of commercial banks to cash their securities and add to the reserve for the purpose of credit expansion.
5. Overvaluation
An overvaluation of domestic currency in terms of foreign currencies will also serve as an anti-inflationary measure. Firstly, it will discourage exports and thereby increase the availability of goods in the domestic market. Secondly, by encouraging imports from abroad, it will add to the domestic supply of goods in the economy. But, overvaluation as an anti-inflationary weapon suffers from several limitations.
6. A suitable income policy
At a time of inflation, the government must also adopt a suitable price-income policy. It should strictly control wages, salaries and profits to keep spending at a low level to fight inflation.
iii) Other Measures
These measures can be used to supplement monetary and fiscal measures undertaken to contain inflationary pressures.
1, Expansion of output
Increased production is the best antidote to inflation because inflation arises partly due to inadequacy of output. But it becomes rather difficult to increase output at a time of inflation because of the full utilization of resources. It is suggested that if it is not possible to increase output as a whole, 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. In other words, a reallocation of productive goods, such as food, clothing, housing, etc. Steps may also be taken to increase supply of consumer goods through large-scale imports from other countries to absorb excess money supply.
2. Wage policy
During an inflationary boom, the wages have to be controlled so as to curb the inflationary pressures in the economy. Wage increases may be allowed to workers only if their productivity increases. If this principle is observed, higher wage shall not lead to higher unit costs and hence, it higher unit prices.
3. Price control and rationing
The object of 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, two conditions will have to be satisfied. Firstly, the government should have under its control adequate stocks of the commodities concerned. Secondly, the demand for the concerned commodities should be controlled through rationing, failing which the richer sections shall be able to buy a major portion of the available stocks.
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