Question

the role inflation plays in our economy and list some specific strategies that can be used for controlling inflation.

Answer 1

ROLE OF INFLATION

In simple, Inflation means an increase in general price level over a period of time. Inflation affects on the cost of living, cost of doing business, borrowing money and every other facet of the economy. Inflation can be both positive as well as negative on economy. If the rate of inflation is high, it affects the whole economy badly. If the inflation is controlled at reasonable levels, it may lead the economy to prosper by enhanced employment opportunities and the consumers have an advantage on their consumption. Inflation adversely affects a country's GDP, because economic growth is measured in GDP. As the price increases it affects the purchasing power and thereby it ends with a growth fall.

METHODS TO CONTROL INFLATION

Inflation in an economy is controlled by both the Central Bank and Government. The Central Bank uses the instrument of monetary policy for controlling inflation and the Government uses fiscal policy.

1.  Monetary Policy

Monetary policy contract the aggregate spending by shrinking the money supply or raising the rate of interest.

-- Higher interest rates reduce demand in the economy, leading to lower economic growth and lower inflation.

Tools of monetary policy

a, Open Market Operations

The central bank sells government securities to the banks and general public. It will reduce the reserves with the bank and liquid funds with the general public.

b, Changing Bank rate

The bank rate may also be raised, which will discourage the banks to take loans from the central bank.

c, Changing the Cash Reserve Ratio (CRR)

Increasing the CRR will reduce the lendings by the banks. Because they need to meet the new higher reserve requirements.

2. Fiscal Policy

It deals with the taxation and expenditure decisions of the government.

The government increase taxes and cut spending. This improves the government’s budget situation and helps to reduce demand in the economy.

3. Wage Control

If the inflation is caused by wage inflation, limiting wage growth can help to minimize inflation.