Monetary Measures to Control Inflation

Monetary policy refers to the actions taken by a central bank to manage the money supply and interest rates in an economy, to achieve goals such as controlling inflation. Inflation occurs when the general price level of goods and services rises over time, often due to increased demand or higher costs. To control inflation, central banks use various measures to reduce the money supply or make borrowing more expensive, which helps slow down economic activity and stabilize prices. Common monetary measures to control inflation include the bank rate, open market operations, and the reserve requirements ratio.

1. Bank Rate

Central banks can increase the benchmark bank rate, which is the rate at which commercial banks borrow from the central bank. By raising this rate:

• Borrowing becomes more expensive for banks, businesses, and consumers.

• Spending and investment decrease as loans and credit cost more.

• Reduced demand for goods and services helps slow the rise in prices, curbing inflation.

2. Open Market Operations:

Through open market operations, central banks sell government securities (like bonds) to banks and financial institutions Such as Re-purchase Agreement (Repo) and Reverse Repo.

• When banks buy these securities, money flows out of the banking system and into the central bank.

• This reduces the money supply and liquidity in the economy.

• With less money available for lending and spending, inflationary pressures decrease.

3. Increasing Reserve Requirements

Central banks can raise the reserve requirement, which is the minimum amount of money that commercial banks must hold as reserves against their deposits, Such as Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR).

• Higher reserve requirements mean banks have less money available to lend.

• This reduces the money supply circulating in the economy.

• Lower lending capacity slows down spending and helps control inflation.

4. Forward Guidance

Forward guidance involves the central bank communicating its future policy intentions to the public and markets:

• For example, signaling that interest rates will remain high or that tightening measures will continue.

• This influences expectations, encouraging businesses and consumers to adjust their spending and investment behavior.

• By shaping economic expectations, forward guidance can help reduce inflationary pressures.