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Inflation impacts the price of everything. This includes basic commodities as well as investments. So, it’s an important concern for any economy. Rising inflation is bad news for households and businesses as it erodes the value of money and drives inequality higher. But how do you control inflation? There are proven approaches that can ensure it is well contained. Read on to learn more about measures to control inflation and why it matters.
Keeping inflation under control is important to the general welfare of an economy. Three big reasons for this include:
The value of money falls when there is inflation. That means that people need more money to purchase the same things. Keeping inflation low allows people to afford things like food, housing and health care.
Stable pricing helps to create a predictable environment for businesses and investors. It fosters long-term investment and stable economic growth.
Inflation impacts the budgets of lower-income households more heavily because these households spend a higher percentage of their income on necessities. Inflation is controlled to correct income inequality and move wealth more equally through society.
Wondering how to control inflation rate? There are several options available. Let’s discuss the different ways to control inflation.
The most important and commonly used method to control inflation is the monetary policy of the Central Bank. Most central banks use high interest rates as the traditional way to fight or prevent inflation.
The most effective measures to control inflation are as follows:
The bank rate policy is essentially the instrument of monetary control in times of inflation. This is known as a tight money policy and occurs when the central bank increases the bank rate. Raising the bank rate makes it more expensive for commercial banks to borrow from the central bank, so they prefer borrowing less. Therefore, the flow of money from commercial banks to the public decreases.
The central bank policy increases the CRR to control inflation, which in turn reduces the lending capacity of the commercial banks. Therefore, flows of money from commercial banks to the public reduce. In the process, it halts the rise in prices caused by banks’ credits to the public.
Open market operations refer to the sale and purchase of government securities and bonds by the central bank. To control inflation, the central bank sells government securities to the public through the banks. This results in the transfer of a part of bank deposits to the central bank account and reduces the credit creation capacity of the commercial banks.
These inflation measures 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 imported items, etc.).
Inflation rises when there is a shortage of goods. To manage this, the government and businesses can improve transport, storage and delivery to make products easier to access and more affordable.
Weakening local currencies are also likely to push up the cost of imports, increasing inflation. When the exchange rate is stabilised and we have a strong currency, it will not just cut down on imported inflation but also reduce pressure on domestic prices.
So, how to control inflation in India? Here are some key tools:
This is the rate at which the RBI lends to banks. The hiking of the repo rate increases borrowing cost, thereby discouraging people from taking loans to spend and helps in curbing inflation. Reducing it will increase borrowing and help growth when inflation is low.
This is the rate at which banks park their surplus money with the RBI. An increase in the CRR can make banks more likely to deposit money with the RBI, which reduces liquidity and helps keep inflation in check.
This is the amount that banks need to keep with the RBI. A higher CRR comes at a cost for the banks as it reduces their lending capacity by limiting money flow, thus effectively contributing towards controlling inflation.
In OMOs, the RBI purchases or sells government securities. By selling them, it takes money out of the market, effectively reducing inflation. Purchasing injects cash into the economy when needed.
This is the scheme through which the RBI issues bonds in order to soak up excess liquidity in the system. This tool is employed to deal with sudden abnormal capital inflows or inflation trends.
Inflation in India is primarily measured using two indices:
1. Consumer Price Index (CPI): It measures the average price change paid by consumers for goods and services such as food, clothing, housing, and medical care. It is a good stand-in indicator of consumer-level inflation.
2. Wholesale Price Index (WPI): It measures price change at the wholesale level, which includes goods like fuel, manufactured products and raw materials. This shows the producer side of the inflation issue and tends to be a leading indicator for CPI.
Despite the best of intentions by central banks and governments to combat inflation, there are a few constraints that prevent them from addressing this:
Inflation is the lack of economic stability and loss of buying power for the citizens of a country. Therefore, it is a thing that needs to be controlled. The control of inflation requires a delicate combination of several measures to curb this practice. Coordinated strategies need to be put in place at the right time to reduce the effect of inflation on families and companies.
The vast majority of attempts to control inflation stem from monetary policies. Higher interest rates mean lower consumer spending and borrowing, which consequently reduces inflation.
Mild inflation is desirable because it encourages consumers to make purchases and businesses to make investments in the economy. However, high inflation causes a decrease in our purchasing power, which can affect both consumers and businesses.
Inflation can be a boon to those who borrow money because the money they will pay back in future years will be worth less. It will also prove to be beneficial for companies that are able to increase prices faster than costs.
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