How can the government control inflation

Fri, 17 Jun Pre-Open

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The Reserve Bank of India (RBI) hiked the interest rates by 0.25% yesterday. This was the ninth consecutive hike by the central bank. The underlying reason for these hikes remains the same - higher inflation. But despite the government's consistent efforts, inflation still seems to be spiraling out of control.

So this leaves us with another question as to what else can the government do to control inflation? Should it keep on increasing interest rates through the monetary policy every few weeks? Well this is not an option that can continue for too long. Higher interest rates force organizations and consumers alike to postpone their buying or spending decisions. This in turn hampers economic growth and leads to problems of unemployment.

Another option that the government has is to use the fiscal policy to check inflation. This means that the government raises tax rates, which in turn would bring down disposable income and would hence impact demand. In addition to this, the government would cut down its own spending as well as borrowing targets as well. This would reduce the demand pulled inflation in the country. But it would come at a great cost of higher unemployment as well as slower economic growth.

The government could choose yet another alternative of direct intervention. It could set limits on the rate of growth of wages. This would reduce the disposable income available to the people and in turn would help curtail demand thereby bringing down the prices. However, in a country like ours, this option is not a very viable one. Labour unions are strong and in such cases would retaliate through strikes. This would just lead to chaos in the country which would lead to more social and economical damage than help the situation.

The last option that the government has is to reform the long-term policies related to labour as well as the supply side. Reforming these policies would remove the bottlenecks that exist in the supply chain. This would effectively help reduce the cost push inflation. Reforming labour policies would help weaken trade unions and give more flexibility for healthier negotiations for both the companies as well as for the employees. This in turn would help control the wage cost inflation in the long term.

As of now, it does appear that India has used the monetary policy effectively to control the demand push inflation (inflation caused by increased demand). However, the fact that inflation rates are still spiraling upwards suggest that the inflation is driven more by costs now. Therefore, it calls for the government to change its policies and look at alternatives to control the same. Otherwise, we may be in for an era of higher inflation rates for quite some time in the future.