Previous Year Question
With reference to inflation in India, which of the following statements is correct?
Controlling inflation in India is the responsibility of the Government of India only.
The Reserve Bank of India has no role in controlling inflation.
Decreased money circulation helps in controlling inflation.
Increased money circulation helps in controlling inflation.
Correct Answer: A
Detailed Solution
Inflation refers to a sustained increase in the general price level of goods and services. It is not merely an increase in the price of one commodity but a broad-based rise in prices.
Option (a) is incorrect
Inflation control is not the exclusive responsibility of the Central Government.
Two major authorities have important roles:
The Central Government can use Fiscal Policy, taxation, government expenditure, subsidies, buffer stocks and supply-management measures.
RBI uses Monetary Policy, policy rates, liquidity management and money-supply instruments.
Central and State Government supply measures are especially important when inflation originates from food shortages or other supply-side disruptions.
Option (b) is incorrect
RBI has a direct role in controlling inflation. It can influence demand and liquidity through instruments such as:
Repo Rate
Standing Deposit Facility—SDF
Marginal Standing Facility—MSF
Cash Reserve Ratio—CRR
Open Market Operations—OMO
Variable Rate Repo and Variable Rate Reverse Repo operations
For example, a Repo Rate increase generally raises the cost of funds for banks. Its transmission to lending rates can moderate credit, consumption and investment demand, thereby reducing demand-side inflation.
Option (c) is correct
A reduction in money circulation or liquidity can help moderate aggregate demand.
This relationship can be represented through the Quantity Equation:
MV = PY
Where:
M = Money Supply
V = Velocity of Money
P = Price Level
Y = Real Output
If money supply expands substantially faster than real output while velocity remains stable, excess demand may increase the general price level. Conversely, moderating liquidity growth can help control demand-pull inflation.
However, reducing money supply cannot independently eliminate every form of inflation. Inflation caused by a poor monsoon, higher crude-oil prices, supply disruption or increased production costs also requires supply-side and fiscal measures.
Option (d) is incorrect
Increased money circulation can provide households and firms with greater spending and borrowing capacity. If output does not increase proportionately, aggregate demand may rise and place upward pressure on prices.
Therefore, increased money circulation may intensify demand-pull inflation instead of controlling it.