MGT1114: Principles of

Macroeconomics

Module 3: Inflation and

Unemployment

Lecture title: Measures to

control Inflation
MEASURES TO CONTROL INFLATION
▪ It is important to control inflation from the very beginning itself
otherwise it completely destroys the economy, (when) it once
takes the form of hyper inflation.
▪ For avoiding the catastrophic results of inflation, various anti-
inflationary measures have been suggested.
▪ Most of these measures try to reduce the collective demand for
goods and services.
1. Monetary measures
2. Fiscal measures

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1. MONETARY POLICY
▪ Increase of inflation during the time after the WWII
revived the faith in power of monetary policy.
▪ Monetary policy is the policy of the central bank of
the country (like RBI), which is the highest
monetary power.
▪ Monetary measures try to control the money in the
economy.

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▪ For stopping inflation,
▪ Increase in quantity of currency should be
postponed.
▪ If there is excess of black money, high value
currency should be invalidated.
▪ In place of old currency, new currency can also be
issued.
▪ Bank deposits, which provide power to credit
creation, become a big part of money supply.
▪ That is why; main relation of monetary measures
should be with controlling bank loans.
▪ For this objective, central bank uses various
control measures like Bank rate policy, open
market operations, and variable reserve
requirement ratio affect the cost and availability
of loan.
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▪ Central bank by increasing the bank rate leads to raising the
interest rates, make investments less attractive.
▪ By suppressing excess demand, inflationary increase in
prices may be stopped.
▪ Bank rate policy is influential, if banks to not have an easy
access to other sources of funds.
▪ Under Open market operations, money supply may be
reduced by sale of government securities.
▪ This measure is better than bank rate policy, because it
directly influences the money supply.
▪ Variable reserve requirement ratio is most successful
measure in controlling inflation, but because of its hard
influences, it is often not used.
▪ By increasing cash reserve ratio central bank can reduce the
amount of loan, which banks may create.
▪ During inflation, by increasing immediate payments on
selective basis and reducing the payment time, consumer
credit facilities are cut down.
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CHALLENGES IN MONETARY POLICY

▪ Effectiveness of monetary measures depends on

the quantity of control used by the central bank
and support extended by commercial banks and
other factors of money market.
▪ In a developing country like India, there is lack of
most of these factors.
▪ That is why monetary policy is less important here.
▪ Apart from this, when inflation happens due to
extension of monetised money (for financing of
war or development plans), then fiscal measures
are more useful, towards which we will now turn.

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2. FISCAL POLICY

▪ Fiscal policy tools are used by governments to

influence the economy.
▪ These primarily include changes to levels of
taxation and government spending.
▪ To stimulate growth, taxes are lowered and
spending is increased.
▪ This often involves borrowing by issuing
government debt.

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▪ Public Expenditure
▪ For controlling price rise, government may reduce its
expenditure.
▪ This measure will reduce public money from the market
and because of this will reduce demand for goods and
services.
▪ Reduction in public expenditure must be used carefully as
an anti-inflationary measure.
▪ Hence government must keep the unnecessary
expenditure to be minimal.

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Taxation:
▪ Taxes determine the disposable income in the hands of the people.
▪ Introduction of new taxes and increase in rate of taxes at one side,
reduces the purchasing power of the people and at the other side,
it creates resources for the government to face inflation.
▪ In this manner, objective of anti-inflationary tax policy should be to
reduce disposable income, which is otherwise spent on
consumption.
▪ Tax revenue received by the government should be used for
maintaining requirement expenditure.
▪ Government must use a good composition of direct and indirect tax.
▪ Income tax, property tax, expenditure tax etc direct taxes reduce
disposable income and create pressure on demand.
▪ Indirect tax, along with extra profit of extensive extension, may also
create general influences.
▪ But indirect taxes prove very heavy for fixed income earners who
had already suffered huge loss due to inflation.
▪ By introducing merchandise tax or other similar taxes on luxury
goods, this discriminating effect may be corrected.
▪ These things are consumed only by the high-income class in the
economy.
▪ But indirect tax is not useful, because it increases cost push inflation
by increasing the price of the goods.

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Public Borrowing and Debts:
▪ Like taxes, main objective of public debt is to reduce the
excess purchasing power puts an upward pressure on the
demand.
▪ If this voluntary borrowing does not create desired results,
government may take support of compulsory borrowing.
▪ Compulsory debt, one form of compulsory saving has been
used in Norway, Belgium and Holland.
▪ For stopping the increase of money extension, government
must postpone the repayment of any of its previous debts.
▪ Part from this, if it is possible, for reducing the present
purchasing power of the people, it should defer a part of the
salary of its employees.
▪ When inflation ends or there is expectation of slump in the
economy, deferred purchasing power may be taken out.
▪ Similarly, during inflation, instead of cash payment of pay
revision arrears, they must be transferred to provident fund
accounts.
▪ During the period of peace, generally compulsory saving and
deferred payments should be postponed.
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 MEASURES TAKEN TO CONTROL INFLATION IN INDIA
1. Action against hoarding & black marketing & enforcing the Prevention of Black-marketing.
2. Effectively enforcing the Essential Commodities Act, 1955 and Maintenance of Supplies of Essential
Commodities Act, 1980 for commodities in short supply.
3. Regular review meeting on price and availability situation is being held at the highest level including at the
level of Committee of Secretaries, Inter Ministerial Committee, Price Stabilization Fund Management
Committee and other Departmental level review meetings.
4. Higher MSP has been announced so as to incentivize production and thereby enhance availability of food
items which may help moderate prices.
5. A scheme titled Price Stabilization Fund (PSF) is being implemented to control price volatility of agricultural
commodities like pulses, onions etc.
6. The Government has imposes stock holding limits on stockiest/dealers of high value commodities like
sugar, onion etc.
7. The Government imposes duty on export of high value commodities or imports them at zero duty for
promoting availability and moderating price rise.
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SOCIAL COSTS OF INFLATION
▪ An economy which is experiencing inflation has to bear
many costs and policymakers, economists and especially
politicians are concerned to make arrangements and take
steps to curb inflation because of public pressure.
▪ The social costs of inflation broadly fall into two categories:
A. Costs of Expected Inflation
B. Costs of Unexpected Inflation

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COSTS OF EXPECTED INFLATION
Unanticipated inflation reduces the validity of the information on market prices for economic agents. It
leads to the cost of unequal distribution of wealth and income among individuals such as between
lenders and borrowers where one tends to benefit at the expense of the other. Unanticipated inflation
also hurts individuals on pension. Workers and firms often agree on a fixed nominal pension when the
workers retire. Since pension is deferred earnings, the workers are essentially providing the firm a
loan. Like any creditor, the worker is hurt when inflation is higher than anticipated. Like any debtor, the
firm is hurt when inflation is lower than anticipated.
1. Shoe-leather Cost:
▪ Increased shoe-leather cost is one of the impacts of expected or predictable inflation. Shoe- leather
cost refers to the cost of time and effort that people spend trying to counteract the effects of inflation.
The term comes from the fact that walking to the bank more regularly during inflation will wear out
shoes more quickly. The shoe-leather cost is now used more generally to describe all the costs
associated with having to hold small amounts of cash.
2. Menu Costs:
▪ In economics, a menu cost is the cost to a firm resulting from changing its prices. The name stems
from the cost of restaurants literally printing new menus during high inflation in order to keep up with
economy-wide changes. However, economists use it to refer to the costs of changing nominal prices
in general.

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3. Inconvenience:
▪ Another cost of inflation is the inconvenience of living in a world where prices are
changing and brings changes in the value of rupee. Money is used as a yardstick for
measuring economic transactions and therefore, when an economy experiences inflation,
that yardstick is changing in length.
4. Relative price distortions:
▪ A fourth type of cost of expected inflation is the distortions of relative price leading to
misallocation of resources. Since market economics rely on relative prices to allocate
resources efficiently, inflation leads to microeconomic inefficiencies.
5. Unfair tax treatment:
▪ Another cost of inflation results from the tax laws. Many provisions of the tax code do not
take into account the effects of inflation. Inflation can alter individual’s tax liability, often in
the ways that lawmakers did not intend.

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COSTS OF UNEXPECTED INFLATION
▪ Unexpected inflation also known as unanticipated inflation is the surprise component of
inflation which people haven’t incorporated in their pricing, costing, etc leading to what is
known as Costs of Unexpected Inflation.
▪ Unanticipated inflation reduces the validity of the information on market prices for
economic agents. It leads to the cost of unequal distribution of wealth and income among
individuals such as between lenders and borrowers where one tends to benefit at the
expense of the other.
▪ Unanticipated inflation also hurts individuals on pension. Workers and firms often agree
on a fixed nominal pension when the workers retire. Since pension is deferred earnings,
the workers are essentially providing the firm a loan. Like any creditor, the worker is hurt
when inflation is higher than anticipated. Like any debtor, the firm is hurt when inflation is
lower than anticipated.

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REFERENCE
▪ https://pib.gov.in/Pressreleaseshare.aspx?PRID=1518044

▪ https://jncollegeonline.co.in/attendence/classnotes/files/1621761386.pdf

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