Effects of Inflation & Measures to Control It

       Effects of Inflation & Measures  To Control It

1) Effects of Inflation on Business

Community:  Inflation is welcomed by

entrepreneurs and businessmen because they stand to profit by rising prices. They find that the value of their inventories and stock of goods is rising in money terms. They also find that prices are rising faster than the costs of production, so that their profit is greatly enhanced.

2) Fixed Income Groups: Inflation hits

wage-earners and salaried people very hard. Although wage- earners, by the grace of trade unions, can chase galloping prices, they seldom win the race. Since wages do not rise at the same rate and at the same time as the general price level, the cost of living index rises, and the real income of the wage earner decreases.

3) Farmers: Farmers usually gain

during inflation, because they can get

better prices for their harvest during

inflation.

4) Investors: Those who invest in

debentures and fixed-interest bearing

securities, bonds, etc, lose during inflation. However, investors in equities benefit because more dividend is yielded on account of high profit made by joint-stock companies during inflation.

5) Inflation will lead to deterioration of

gross domestic savings and less capital formation in the economy and less long term economic growth rate of the economy.

MEASURES TO CONTROL INFLATION

The measures to control inflation can be

broadly divided into TWO- Monetary and

Fiscal Measures. Inflation is primarily a monetary phenomenan.Hence, the most logical solution to check inflation is to check the flow money supply by devising

appropriate monetary policy and carefully

implementing monetary measures. The Central bank’s monetary management methods, devices for decreasing or increasing the supply of money and credit

for monetary stability is called monetary

policy. Monetary policy is a policy of money supply influencing the quantity, cost and availability of money supply. Central Banks generally use the three quantitative measures namely:

1) Bank Rate Policy

2) Open Market Operations

3) Variable Reserve Ratio

1) Bank Rate Policy: Bank rate is the

rate at which Central Bank lends loans

and advances to commercial banks. When bank rates are hiked by the Central bank as a follow up of this increased bank rate, commercial banks hike the rate of interest. Bank rate is hiked during the period of inflation to reduce money supply.During the period of falling prices (deflation) central banks reduces bank rate to increase money supply. As follow up, commercial banks reduce rate of interest. At a low rate of interest, investors find it much attractive to borrow money and make investment.

2) Open market Operations: Open

market Operation means open buying and selling of government securities by the Central Bank for the Central Government. In India the term ‘opens market operations’ stands for the purchase and sale of government securities by the RBI from/to the public and banks on its own account. In its capacity as the government’s banker

and as the manager of public debt, the RBI buys all the unsold stock of new government loans at the end of the subscription period and thereafter keeps them on sale in the market on its own account. Such purchases of government securities by the RBI are not genuine market purchases but constitute only an internal arrangement between the government and the RBI whereby the new government loans are sold not directly

by the government but through the

RBI as its agent.

3) Variable Reserve Ratio: Under the

existing law enacted in 1956, RBI is

empowered to impose statutorily ‘Cash Reserve Ratio’ (CRR) on commercial banks anywhere between 3 per cent and 15 per cent of the net demand and time liabilities. It is the authority of the RBI to vary the

minimum CRR which makes the variable reserve ratio a tool of monetary control. It may be noted that the RBI pays interest to banks on the additional required reserves over the minimum CRR of 3 per cent.