Inflation: Definition, trends, estimates, consequences, and remedies (control): WPI, CPI - components

and trends; striking a balance between inflation and growth through monetary and fiscal policies.

Q1: Suggest suitable options for controlling inflation.

Ans: Inflation refers to that state of economy in which there is rise in prices of goods and
services over a period of time. This may be caused by excess demand by the public in general or
reduced supply of goods and services in the economy.

Below given options can be exercised to control the level of inflation in the economy:

1) Monetary Measures
There are certain measures that are taken by the central bank of the country to control the
money supply in the economy.

A) Adopting Hawkish monetary policy: Increase in Policy rate (Repo rate): It is the rate of
interest at which central bank lends money to the banks in the country for short-term
purposes. By hiking the repo rate, central bank makes the credit expensive for the
banks, which eventually raise their interest rates for various loans, thus making credit
unattractive for the public at large.
Thus, low credit creation means less money in the hands of the public, thus lowering aggregate
demand for the goods & services.

B) Increasing the statutory Ratios: Central bank of the country can increase statutory
ratios such as Cash Reserve Ration (CRR) and Statutory Liquidity Ratio (SLR), thereby
decreasing the level of money supply in the economy.
As per research, increase of 1% in CRR sucks out approximately 1 Lac crore from the
economy.

C) Conducting Open Market Operations (OMO):

Central bank can sell Government Securities (G-Sec) on behalf of the Union
Government thus absorbing excess liquidity in the market.

D) Credit control measures: Managing Loan to Value (LTV) Ratio & Loan Margin
Requirement:
Central bank may direct the banks to decrease LTV ratio and to increase loan down
payment value, thus decreasing money supply in the economy.

2) Fiscal Measures
Similarly Union Government can take certain measures as given below, to tackle both
demand & supply side constraints to cool down the inflation:

A) Reducing personal consumption: Imposing higher direct taxes: Union government

can impose higher direct taxes such as income tax, corporation tax etc., thus leaving
people with less money in hand to spend.
 B) Imposing Stock hoarding limit: If inflation is prevailing due to supply side
constraints, then Union Government can impose certain restrictions on hoarding of
those items such as onions, tomato etc.
C) Reducing Indirect taxes on petroleum products:
Reducing Government Expenditure:

Increase saving & investment of public

3) Other Measures

Price Control

Incentivize Production

Increase Production efficiency

Q2: Monetary measures have failed to control inflation in India. Explain.

Ans: In 2016, Union Government of India amended the Reserve Bank of India (RBI) Act, 1934 and asked
monetary policy committee (MPC) to contain inflation within 4% with a tolerance of 2% on either sides.

Since, then MPC/ RBI have been successful in achieving an average inflation of around 3.5% in the last
five years, as compared to average inflation of 5.7% which was achieved during five years before
inflation targeting framework came into effect.

CPI-based inflation during FY21-22 averaged 5.5 per cent, 6.2 per cent for FY
20-21.
Yes, it is true that, at times, inflation have overshot the upper band of 6%, specially after lockdowns
imposed due to COVID-19 pandemic, but this rise happened due to supply-side disruptions /constraints
not due to excess money supply in the economy.

Moreover, RBI is able to control inflation only when it is due to rise in aggregate demand in the
economy, therefore it becomes imperative for the Union government to manage supply-side disruptions
to keep a check on the inflation.

Q3. “High inflation is a source of internal and external disequilibrium”-Explain

the statement with reference to CAD (Current Account deficit) and weakening of
the rupee.

High inflation is a source of internal and external disequilibrium.

It causes real consumption demand to fall along with lowering of household savings that provide the
bulk of financial surpluses to support private and public investments.

High consumer price inflation does not help public finances either as it puts pressure for larger fiscal
subsidies.

As domestic savings get eroded, it widens the external gap reflected in the CAD. High inflation also
means large inflation differential vis-à-vis global trading partners which then makes the economy
vulnerable to currency pressures.

India’s current macroeconomic deterioration to a large extent, reflects the three years of high inflation,
which is well above the threshold at which it turns detrimental to growth. While the fall in headline WPI
inflation affords some comfort, it is important to bring consumer price inflation under control.