We all know what inflation is and ofcourse, we all want our economy to be free from Inflation. But it is not as simple as it seems. To solve the problem of inflation what is more important is to understand the cause and the main root of inflation.
Putting in simple words, the growth in money supply causes inflation. As Quantity Theory Of Money states – if the money supply is stable, the prices level will be stable. But if their is increase in money supply rapidly, the prices level will rise rapidly.
Now the question that comes into picture is ‘ what causes the growth in money supply? ‘
Government need money to buy goods and services, for transfer payments, for public warfare and many other things. In order finance these, government uses it’s revenue which it raises through taxes. But sometimes the revenue does not satisfy all the needs. Thus, to increase the revenue government opt for SEIGNIORAGE, which means increasing revenue by printing money. This in return, causes the increase in money supply in the economy. Further, causing inflation.
Hence, printing of money by central government to finance expenditure is the major cause of INFLATION.
Coming back to question, “How inflation can be controlled? ”
In simple terms, government should reduce its expenditure, increase taxes or should sell its bond to the public. But individually these does not end the problem, so government form some stabilisation programmes which include elements like ;
* Fiscal Reform, which should take place on both the sides of the budget. On revenue side, instead of increasing the overall taxes, government should change the composition of taxes and, on the expenditure side, government should reduce the subsidies.
* Credible Commitment must be made be central bank, which can be done like, central bank should be prohibited from buying government debt or it should make foreign currency as countries official currency.
* Income Policies should also be followed with fiscal and monetary measures. If firms know wages will not increase, they will not increase prices and if workers know prices will not increase, they will not ask for increase in wages.
Thus, inflation can be controlled if the policy is made with the mix of fiscal, monetary and income measures.