Q. With reference to inflation in India, which of the following statements is correct?

• Controlling the inflation in India is the responsibility of the Government of India only
• The Reserve Bank of India has no role in controlling the inflation
• Decreased money circulation helps in controlling the inflation
• Increased money circulation helps in controlling the inflation

Answer: (c) Decreased money circulation helps in controlling the inflation

Inflation:

• Inflation, as defined by the International Monetary Fund, is the rate of increase in prices over a given period, encompassing a broad measure of overall price increases or for specific goods and services.
  • It reflects the rising cost of living and indicates how much more expensive a set of goods and/or services has become over a specified period, usually a year.
    • In India, inflation’s impact is particularly significant due to economic disparities and a large population.
• Different Causes of Inflation:
  • Demand-Pull Inflation:
    • Demand Pull inflation occurs when the demand for goods and services exceeds their supply. When the overall demand in the economy is high, consumers are willing to pay more for the available goods and services, leading to a general rise in prices.
      • A booming economy with high consumer spending can create excess demand, putting upward pressure on prices.
  • Cost-Push Inflation:
    • Cost-push inflation is driven by an increase in the production costs for goods and services. This can be caused by factors such as increased incomes, increased costs of raw materials, or disruptions in the supply chain.
  • Built-In or Wage-Price Inflation:
    • This type of inflation is often described as a feedbackloop between wages and prices. When workers demand higher wages, businesses may raise prices to cover the increased labor costs. This, in turn, prompts workers to seek higher wages, and the cycle continues.
      • Collective bargaining by labor unions can result in higher wages, leading to increased production costs and subsequently higher prices for goods and services.

How To Control Inflation?

• There are broadly two ways of controlling inflation in an economy:
  • Monetary measures
  • Fiscal measures
• 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:
    • bank rate policy
    • cash reserve ratio and
    • open market operations.
  • Bank rate policy
    • 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 the 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.
• 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 domestic consumption, encouraging imports by lowering duties on import items etc.).
  • Supply Measurement Measures:
    • Supply Management Measures aims to increase the competitiveness and efficiency of the supply chain, putting downward pressure on long-term costs. 
    • Some of the supply management measures taken are-
      • Restricting exports of commodities in short supply and increasing their imports.
      • Effective implementation of the Essential Commodities Act, 1952 to prevent hoarding and speculation. 
      • Incentivizing the increase in production of commodities through tax concessions, subsidies, institutional support etc. 
      • Higher MSP has been announced to incentivize production and thereby enhance the availability of food items which may help moderate prices.
      •  Fixing the ceiling prices of the commodities and taking measures to control the black marketing of those goods. 
      • Reforming the supply chain through infrastructure development, foreign investments etc.