Today most central banks are tasked with keeping inflation at a low level, normally 2 to 3% per annum within the targeted low inflation range which could range from 2 to 6% per annum.
It has been noted that inflation inflicts much suffering on the helpless people and disrupts society economically, socially, morally and politically. Hence, there is need for controlling inflation. There are a number of methods that have been suggested to control inflation. Control of inflation requires an integrated set of measures which may be classified as monetary, fiscal, direct controls and other measures.
- Monetary measures:
The central Bank should use both quantitative and qualitative techniques of credit control in order to achieve the objective of controlled expansion of credit. Central banks such as the U.S. Federal Reserve can affect inflation to a significant extent through setting interest rates and through other operations (i.e., using monetary policy). High interest rates and slow growth of the money supply are the traditional ways through they have different approaches. For instance, some follow a symmetrical inflation target while others only control inflation when it rises above a target, whether express or implied.
Monetarists emphasize increasing interest rates to fight inflation. Keynesians emphasize reducing demand in general often through fiscal policy, using increased taxation or reduced government spending to reduce demand as well as by using monetary policy. Supply-side economists advocate fighting inflation by fixing the exchange rate between the currency and some reference currency such as gold. This would be a rerun to the gold standard. All of these policies are achieved in practice through a process of open market. The bank rate may be raised; Securities may be sold in the open market and even resource ratios may, be increased. These steps would curb credit expansion by the commercial banks and hence control inflationary pressures in the economy.
However, anti-inflationary monetary policy suffers from certain limitations. First, since marginal efficiency of investment is too high during inflationary period, investment may become interest inelastic. Besides this, if the banks have excess reserves, the central banking techniques of monetary management may not be of much use in combating inflation. Similarly, if there is deficit induced inflation, the Central Bank can hardly do any thing to curtail the excessive monetary demand which has arisen due to structural deficiencies.
Notwithstanding its limitations, monetary policy has a role. It can assist in the expansion of productive sectors of the economy and restrict speculative inventory build-ups. In short, we may say that monetary measures should be used along with other measures to keep the inflation under control, even though its role is relatively a modest one.
- Fiscal Measures
The policy related to public expenditure, public revenue and public debt is known as fiscal policy. The main anti-inflationary fiscal measures are as follows:
(1) Reduction in public expenditure:
Increase in the volume of public expenditure can contribute much to inflation by increasing the disposable income in the hands of the people. Moreover, public expenditure, being autonomous in nature, has a multiplier effect on the levels of income, output and employment of the country. Therefore, reduction in government spending is bound to reduce inflationary pressure.
(2) Increase in Taxes:
Mobilization of additional resources in the form of higher taxation also helps in combating inflation. As more taxes are imposed, the size of disposable income is reduced and thus the inflationary gap is narrowed down. All this effort will help in reducing the inflationary pressures in the country.
(3) Control over Deficit Financing:
Deficit financing has been held to be the root cause of inflation in many countries. Excessive deficit financing and the resultant increase in money supply often lead to inflationary pressures. Therefore, the government should keep its deficits to the minimum possible when the economy is threatened with inflation.
(4) Increase in public Borrowings:
During inflationary period, the government may launch a campaign to increase savings and thus reduces the extra purchasing power. The government may offer to the people bonds which bear attractive interest rates. If price rise assumes an alarming proportion, the government may force the people to save some portion of their incomes compulsorily. Ultimately, these activities of the government controls inflation. Despite it has some imitations, but fiscal measures are important instruments of anti-inflationary strategy. When used in co-ordination with monetary policy, fiscal policy serves a very useful purpose in fighting inflation.
- Other Measures
Apart from monetary and fiscal measures, direct controls and other measures may also be used to control inflation. Direct measures may be both voluntary and compulsory. The people may be persuaded to save more by restraining expenditure on inessential consumer goods. But direct measures may also contain an element of compulsion. The government may take certain compulsory deductions from salaries and wages to credit it to the employee’s saving fund account. Thus, a part of purchasing power of the people can be kept blocked as long as the inflationary pressures are not relieved.
Direct measures also include price controls and rationing. Price control and rationing may prove helpful in arresting inflationary pressures only if an efficient public distribution system exists. Shortages of essential consumer goods will encourage black market transactions and the scope of black money will also increase. Therefore, direct controls must be accompanied by an active enforcement mechanism.
During the period of galloping inflation, an appropriate income policy may also have to be controlled. Ceilings on wage payments and also on dividend payments may be imposed. These policies will keep down the disposable income and narrow down the inflationary-gap. On the other side, checks on wages and profits keep the cost of production low and hence const-push inflation will be checked.
The ultimate remedy against inflation lies in increasing production in all the sectors, for anti-inflation measures are only short-run measures. Intensive farming and full use of industrial capacity can go a long way in controlling inflation. In fact, it is the effective remedy for inflation.
The contribution of non-economic factors in combating inflation should also not be minimized. Peaceful atmosphere, political stability, firm and dynamic leadership, efficient and honest administration, promoting standards of efficiency and sense of responsible citizenship are the prerequisites for any sound policy to combat inflation.
Thus, we find that in order to control inflation we need a multipronged policy of co-ordinating short-period and long-period measures. Only then, we can hope to keep