Economic Policies to Control Inflation

Inflation has to be controlled, otherwise the extent of damage done to the economy will be something substantial and the economy would take a long time to recover from the effects of inflation. In this direction of control of inflation, the following are the theoretical measures available. These measures could be classified into three groups viz. Monetary measures, Fiscal measures and Other measures.

1. Monetary Measures

Monetary measures are steps taken by the Central bank of a country as the head of the monetary system. These measures are usually refereed to as the, quantitative credit controls and qualitative credit controls. The former include bank rate, open market operations and the variable reserve ratio. The, latter include margin requirements, moral suasion, direct action, control through directives, consumer credit regulation or rationing, publicity, etc.

  1. Quantitative Credit Controls: Bank rate is the first, measure to curb credit creation activity of the commercial banks, as during inflationary period the volume of money supply has to be reduced. Bank rate is the rate at which the central bank of a country re-discounts the bills already discounted by the commercial banks. When the central bank wants to control credit creation by commercial banks, it would simply increase the bank rate. Correspondingly the commercial banks would increase the discount rate which acts as a disincentive for the businessmen and others to approach the commercial banks for discounting their bills. However, the success of this policy depends on the co-operation of the commercial banks. Open market operations are another quantitative credit control measure.  In this, the central bank would buy or sell securities in the open market which are sold or purchased by the commercial banks for cash. During inflationary situation, the central bank would sell securities in the open market, and when the commercial banks purchase them, for cash then capacity of the commercial banks to create credit will be very much restricted. With less credit created, the money supply in the economy will come down bringing down the pressure of inflation. The third policy is variable cash reserve ration. As per statute, every commercial bank should maintain a certain percentage of its total deposits in terms of cash reserve with the central bank. The percentage of reserve to be maintained, called as cash reserve ratio, is determined by the central bank. By increasing the cash  reserve requirement, the central bank can reduce the cash available with the commercial banks thereby controlling their capacity to create credit.
  2. Qualitative Credit Controls: Qualitative credit controls aim at channelizing the available funds in the most productive uses or applications. In terms of various measures the central bank can govern the credit policies of the commercial banks. The first of these control measures is the margin requirements. According to this policy, the central bank specifies the amount of margin that each commercial bank should maintain while lending on securities to the common public. By increasing the margin requirements, the central bank can discourage borrowings on certain securities. If the central bank wants to help the priority sector it can accordingly instruct the commercial banks to maintain a lower margin on securities offered for borrowing for priority purposes. Moral suasion refers to the persuasive technique adopted by the central bank with; the commercial banks in making the later understand the need to pursue a particular type of credit control policy. Though the central bank is empowered with statutory powers to regulate the commercial banks, yet the central bank believes persuasive policies rather than using its statutory authority. Central bank can also issue directives to the commercial banks outlining the details of the objectives of the various credit control policies, the need to follow them, the expected result of them, etc. This will help the commercial banks to understand and co-operate with the central bank in times of financial crisis. Central bank also regulates the flow of credit towards consumer requirements. This called as regulation of consumer credit. The central bank can even specify the types of consumer credit which could be encouraged and those that could be discouraged. On receipt of directions from the central bank, the commercial bank act accordingly, either by liberalizing consumer credit or restricting consumer credit. Direct action may also be taken by the central bank to control the commercial banks. This can range between issuing warning to cancellation of license. But in practice central bank never resorts to this measure as all the commercial banks invariably follow the policies of the central bank.

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