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How To Control Inflation?

India Infoline News Service | 14 Aug, 2010 | 7:53 AM

There are broadly two ways of controlling inflation in an economy:

1). Monetary measures and

2). Fiscal measures

I).Monetary Measures
The most important and commonly used method to control inflation is monetary policy of the Central Bank. Most central banks
use high interest rates as the traditional way to fight or prevent inflation.

Monetary measures used to control inflation include:

(i) bank rate policy
(ii) cash reserve ratio and
(iii) open market operations.

Bank rate policy is used as the main instrument of monetary control during the period of inflation. When the central bank raises
the bank rate, it is said to have adopted a dear money policy. The increase in bank rate increases the cost of borrowing which
reduces commercial banks borrowing from the central bank. Consequently, the flow of money from the commercial banks to
the public gets reduced. Therefore, inflation is controlled to the extent it is caused by the bank credit. 

Cash Reserve Ratio (CRR) : To control inflation, the central bank raises the CRR which reduces the lending capacity of the
commercial banks. Consequently, flow of money from commercial banks to public decreases. In the process, it halts the rise in
prices to the extent it is caused by banks credits to the public.
 
Open Market Operations: Open market operations refer to sale and purchase of government securities and bonds by the central
bank. To control inflation, central bank sells the government securities to the public through the banks. This results in transfer
of a part of bank deposits to central bank account and reduces credit creation capacity of the commercial banks.

II). Fiscal Measures

Fiscal measures to control inflation include taxation, government expenditure and public borrowings. The government can also
take some protectionist measures (such as banning the export of essential items such as pulses, cereals and oils to support
the domestic consumption, encourage imports by lowering duties on import items etc.).

Also Read:

What is Inflation?
 
What are the different types of Inflation?

What is CRR, repo and reverse repo rate?

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