Contraction Monetary Policy to manage Inflation

When aggregate demands rises sharply due to large consumption and investment expenditure or more importantly, due to the large increase in government expenditure relative to its revenue resulting in huge budge deficits, a demand-pull inflation occurs in the economy. Besides, when there is too much creation of money for one reason or the other, it generates inflationary pressures in the economy. The following monetary measures, which constitute tight money policy, are generally adopted to control inflation:

(i)   Promotion rule Securities: The Central Bank sells the Government securities to the banks, other depository institutions and the general public through open market operations. This action will reduce the reserves with the banks and liquid funds with the general public. With less reserve with the banks, their lending ability will be reduced. Therefore, they will have to reduce their demand deposits by refraining from giving new loans as old loans are paid back. As a result, money supply in the economy will shrink.

(ii)  Add to Bank Rate: The bank rate may also be raised which will discourage the banks to take loans from the central bank. This will tend to reduce their liquidity and also induce them to raise their own lending rates. Thus this will reduce the availability of credit and also raise its cost. This will lead to the reduction in investment spending and help in reducing inflationary pressures.

(iii) Adapting Anti-inflationary actions: The most important anti-inflationary measures are the raising of statutory Cash Reserve Ratio (CRR). To meet the new higher reserve requirements, banks will reduce their lending. This will have a direct effect on the contraction of money supply in the economy and help in controlling demand pull inflation. Besides Cash Reserve Ratio (CRR), the Statutory Liquidity Ratio (SLR) can also be increased through which excess reserves of the banks are mopped up resulting in contraction in credit.

(iv) Use of Qualitative acknowledgment manage calculate: Fourthly, an important anti-inflationary measure is the use of qualitative credit control, namely, rising of minimum margins for obtaining loans from banks against the stocks of sensitive commodities such as food grains, oilseeds, cotton, sugar, vegetables oil. As a result of this measure, businessmen themselves will have to finance to a greater extent the holding of inventories of goods and will be able to get less credit from banks.

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