Measurement of Inflation (Managerial Economics Notes) (BBA/MBA Notes)

Controlling inflation

The control of inflation is of critical importance for the successful management of the macro-economy. The tools, available in the hands of government and central banks, generally work indirectly via change in aggregate demand and aggregate supply. The policy kit of a government includes standard, traditional as well as innovative instruments to address the problem of inflation.
The measures for controlling inflation can be divided into three broad categories:
1. Monetary measures,
2. Fiscal measures, and
3. Direct controls and other measures.

Since the first two categories of measures have been discussed in detail in chapters on Monetary Policy and Fiscal Policy, we shall make mention of these here very briefly.

1. Monetary Measures
The central bank of the country can curb inflation by restricting the supply of money and credit with the help of three important weapons available to it viz. (i) bank rate policy, (ii) open market operations and (iii) varying the reserve requirements of the member banks. Monetary measures, however, are not very effective in underdeveloped countries lacking a well-developed and integrated money market. In underdeveloped countries, selective credit control is preferable to the general credit control. Care should be taken that the credit control measures do not restrict the supply of credit for development projects.
Not to talk of underdeveloped countries, monetary policy has not been very effective in curbing inflation even in advanced countries. Prof. Hansen assigns monetary policy only a secondary role in controlling inflation. It cannot be the primary measure. No doubt, a sufficiently sharp reduction in the supply of money may quickly end an inflation. But stopping an inflationary development simply by reducing the quantity of money may involve dangerous consequences. To cite Hansen, “moderately used, monetary policy courts the failure of ineffectiveness; pushed to the needed fanatical extremes, it courts disaster.”

2. Fiscal Measures
The limitations of monetary measures make it important to make use of fiscal measures to curb inflation. Fiscal measures refer to taxation, government spending and public borrowing. Government should try to mop up through taxation as much purchasing power as possible without adverse effects on incentives to enterprise and invest. In underdeveloped countries, there exists considerable evasion of taxes. Measures should be taken to check this evasion.
Today the government accounts for a considerable portion of the total expenditure. It should cut down all its unnecessary and wasteful expenditure and try to work in the most economical manner.
Private savings have a strong disinflationary effect. The government should take measures to promote private savings. A strong savings drive reduces the spendable incomes of the people without involving harmful effects of the type associated with higher taxation. Further, public debt should be managed in such a manner that the supply of money in the country is controlled. The government should avoid paying back any of its past loans during inflationary periods so as to prevent an increase in the circulation of money.
Voluntary saving schemes may, however, be of limited success, particularly among poor classes who may not be able to avoid the temptation of spending their increased incomes on goods which they could not afford to buy for long. Keynes, therefore, suggested a programme of compulsory saving like “deferred pay” or “forced savings” to control inflation. “Deferred pay” implies that a part of the pay of the workers is credited to their savings account and would not be available for spending so long as the inflation lasts. Such compulsory saving schemes are expedient during war-time, or during post-war hyper-inflation, but are not practicable in peace time, particularly in democratic societies.

3. Direct Controls and Other Measures
Many countries have resorted to price control and rationing for checking a rise in prices, particularly, in case of essential commodities. Rationing and price control, however, have not been very effective in underdeveloped countries because of a lack of competent and honest machinery to administer these. These have often led to the disappearance of goods from the market, black marketing, bribery and corruption. Keynes objects to price control on the ground that it fails to bring about equilibrium between purchasing power and available output. Further, it is also detrimental to the consumer’s sovereignty, freedom and welfare. Prof. Kurihara observes that when administrative difficulties in enforcing price control and legal restrictions against black marketing are considered, price control becomes dim by the side of monetary-fiscal policy. Keynes also objects to rationing because it “involves a great deal of waste, both of resources and of enjoyment.” Kurihara, however, suggests that “a sensible progress of rationing should aim at diverting consumption from particular articles whose supply is below normal rather than at controlling aggregate consumption.”

Measures should be taken to expand the production of necessary goods at the expense of luxury goods because a shortage of the former type of goods raises the prices much more rapidly than a shortage of the latter type of goods.

Control of wages has often been suggested to check a wage-price spiral. During galloping inflation it may be necessary to apply a wage-profit freeze. Control of wages and profits keeps down disposable income and, hence, the level of effective demand for goods and services.

Efforts should be made to obtain as much foreign capital as possible. Investment financed by foreign capital is less inflationary.

In some cases, relaxation of restrictions on imports may lighten inflationary pressures by increasing the supply of essential goods available in the country. Similar effects may be obtained by a curtailment of exports. But increase in imports and curtailment of exports are possible only if the country is having a very easy balance of payments position.

Every effort should be made to increase production. Preference should be given to investment in those projects which start yielding production earlier.

It is now widely believed that inflation can easily be controlled in the initial stages but when it goes beyond a certain stage, it assumes such dimensions that it becomes very difficult to control it. A hyper-inflation, for instance, can be removed only by replacing the old currency by a new currency.

Inflation is a hydra-headed monster and should be fought with many weapons. Dependence on a single measure may not help much in curbing inflation.

Measurement of Inflation (Managerial Economics Notes) (BBA/MBA Notes)

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