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Unit 11: Control of Inflation and Philips Curve

as stated before do make the rupee an attractive destination for investments leading to an Notes
increase in demand for the rupee and the consequent appreciation. But this is subject to the
condition that higher interest rate is not subject to higher risk premium. For, a cheap currency is
conducive to foreign investments, a volatile currency is definitely not.
The days of trade balances determining the exchange rate are history since today the rates are
more a function of capital flows. But the recent economic sanctions and the consequent downgrade
by Moody’s and S&P has resulted in a “wait and watch” policy adopted by most Flls and foreign
investors. Additionally, with the private foreign funds for the Indian private industry drying
up, there is likely to be a fall in the ECB’s that will exert additional pressure on the rupee.

Self Assessment

State whether the following statements are true or false:

1. The short-term effect of attempts to contain inflation may well be reductions in output and
employment.
2. A higher than average rate of inflation in one country may have adverse repercussions on
the private corporate sector.
3. Inflation for the companies would result in an increased rate of growth in real demand for
goods and services.
4. Higher interest rates can also come from the inefficiencies of the banking system.
5. High real interest expectations cause lower savings.

11.2 Control of Inflation

In view of the serious repercussions of inflation on the economy, various measures are taken to
control inflation:
1. Monetary Policy: In almost all countries, central banks enjoy extensive powers to introduce
various monetary measures to control inflationary price rise. These measures include the
bank rate policy, open market operations, variable cash reserve ratio and selective credit
control.
2. Fiscal Policy: Fiscal policy seeks to control inflation through controlling taxes, public
expenditure and government borrowing. Since government spending has become an
important component of aggregate spending in almost all countries, by changing its
expectations in relation to its tax receipts, the government can exert a powerful effect on
the flow of money, aggregate demand and economy activity.
3. Wage Control: Wage control is a measure to deal with cost push inflation which occurs
when money wage rate rises faster than productivity of labour. However, wage controls
are generally arbitrary and difficult to implement. It perpetuates the existing inequality
in income distribution and will not be tolerated by income recipients for long period.
4. Price Control: The system of price control implies the fixation of maximum prices at
which commodities are to be sold. However, this will lead to increase in quantity demanded
and decrease in quantity supplied because the fixed price has to be below the market
equilibrium price. Thus, this method is seldom resorted to.
5. Indexation: It is a method in which, such adjustments in monetary returns are made that
are necessary to set off losses in real incomes due to inflation.

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