Control inflation by acting on liquidity

News: Inflation has assumed a menacing proportion in almost all countries.

Consumer price index (CPI) inflation in India stood (in March 2022) at 6.95%. It is expected to rise further in April. On the other hand, the Wholesale Price Index (WPI) inflation had remained in double digits since April 2021.

It is not the case solely with India, the situation is the worst in the United States where the consumer price inflation stood (in March 2022) at 8.56%

Monetary and fiscal policy approach adopted after pandemic

After the advent of COVID-19, the major concern of policymakers all over the world was to revive demand. Government’s tried to increase demand by raising government expenditure. However, it didn’t happen due to supply constraints that came from a non-mobility of factors of production.

But it is the right approach, the increase in output could happen with a lag and also with the relaxation of restrictions.

The focus of monetary policy in India also has been to keep the interest rate low and increase the availability of liquidity through various channels.

The Government’s borrowing programme also went through smoothly, due to abundant liquidity.

Changing Policy measures due to inflation

Although the monetary policy is still accommodative, the focus is back on the gradual withdrawal of accommodation, to ease inflationary pressure.

What should be done?

Many experts are of the belief that present inflation is cost-push inflation that occurred due to rising crude oil prices and the Russia-Ukraine war.

Thus, some part of the increase in crude prices and food prices can be absorbed by the government.

However, an abundance of liquidity has also been an important factor. Thus, action on liquidity is very much needed, with a concomitant rise in the interest rate on deposits and loans.

Source: This post is created based on the article “Control inflation by acting on liquidity” published in The Hindu on 11^th May 2022.