Page 205 - DECO402_Macro Economics

Macroeconomic Theory

Notes (iv) Because of inflation (demand pull), personal investment increases many folds. Capital
building is induced by real capital investment. Investors for receiving more profits, start
stocking goods, because of which black marketing emerges. With globalisation and open
door policy, foreign direct investment is motivated.
(v) Tax inflow of the government increases, from which increasing public expenses are
managed. Apart from this, actual load of public debt is reduced.

Self Assessment

State whether the following statements are True or False:
1. Slow inflation is not only required but also an important condition for economic
development.
2. Inflationary gap is not created due to extra spending by the government.
3. Due to inflation investors of shares generally earn profits.
4. Small farmers engaged in livelihood earning farming are not much influenced by
inflation.

22.5 Control of 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. These measures may be explained under three
heads in the name of monetary measures, Fiscal measures and other measures.

1. Monetary Measures

Increase of inflation during the time after the Second World War revived the faith in power of
monetary policy, though as per Keynes, it proves un-influential in controlling the slump. Monetary
policy is the policy of the central bank (RBI) of the country, which is the highest monetary power.
Monetary measures try to control the money in the economy. 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 quantitative and qualitative (selective) control measures. Quantitative measures like
Bank rate policy, open market operations, and variable reserve requirement ratio affect the cost and
availability of loan.
Central bank by increasing the bank rate may easily by 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. It its success in controlling
credit and in this manner, controlling inflation, depends on attractiveness of these securities and on
existence of organised money market. 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 (that) loan, which banks may create.

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