Which of the following measure is adopted to reduce inflation?
- Reduction in bank rate
- Reduction in Repo rate
- Increase in government expenditure
- Cuts in government spending
Correct Answer: Cuts in government spending
It is prudent to reduce government spending if one wants to reduce inflationary pressures within an economy. When a government opts to decrease its expenditures, it directly impacts the demand for goods and services, which, in turn, can reduce inflationary pressures.
When the government reduces its spending, it effectively curtails the flow of funds into the economy. With fewer funds available for public projects, subsidies, and social programs, the overall demand for goods and services decreases. In particular, if demand-pull factors are driving up prices, this decrease in demand can help combat inflation.
The fiscal authorities aim to create a scenario in which the overall level of demand corresponds more closely to the productive capacity of the economy by reducing government spending. Inflation rates can be moderated if demand matches or slightly exceeds supply of goods and services, relieving upward pressure on prices.
In order to avoid causing undue economic hardship or negatively impacting essential public services, it is important to carefully calibrate cuts in government spending. Furthermore, the effectiveness of this measure will depend on the economic context and the underlying causes of inflation.
Why the other options are not correct
a. Reduction in bank rate:
While lowering the bank rate (or policy rate) can indeed stimulate economic activity and influence borrowing costs. It is generally regarded as a growth measure rather than a direct measure to reduce inflation. By lowering the bank rate, borrowing and spending are encouraged. But this does not necessarily resolve the root causes of inflation.
b. Reduction in repo rate
In a similar manner to a reduction in the bank rate, a reduction in the repo rate aims to lower banks’ borrowing costs. Like the bank rate, this measure aims primarily to stimulate economic activity and lend rather than directly reduce inflation.
c. Increase in government expenditure:
It is usually used as a countercyclical measure to boost economic growth during times of recession or low activity to increase government expenditure. Although it can increase demand and stimulate economic activity, it does not serve as a direct policy measure for reducing inflation.
In conclusion, cuts in government spending can be used as a policy measure to combat inflation by reducing the demand for goods and services. Inflationary pressures can be alleviated by aligning demand with the economy’s productivity capacity. In the broader economic context, however, the effectiveness of such a policy needs to be carefully assessed.