Inflation: previous-year questions

Answer: (A) Deflation

Deflation is a sustained fall in the general price level, i.e. negative inflation. Disinflation (B) is only a fall in the rate of inflation, with prices still rising but more slowly; stagflation (C) is stagnant growth and high unemployment together with high inflation, as in the oil shocks of the 1970s; and depression (D) is a severe, prolonged fall in output and employment, like the Great Depression of 1929. Related terms: reflation (deliberate stimulus to pull an economy out of deflation), hyperinflation (runaway price rise) and core inflation (excluding food and fuel). In India inflation is measured by the CPI, and the RBI's target is 4% with a band of plus or minus 2%.

Answer: (D) Increase in money supply

Inflation is controlled by reducing the amount of money chasing goods, so increasing the money supply (D) would feed inflation, not fight it. The real anti-inflationary tools are monetary (the RBI raises the repo rate, CRR and SLR and sells securities in open market operations), fiscal (lower government spending, higher or better-targeted taxes, which is how curbing disposable income and tax reform work) and administrative (action against hoarding and black marketing under the Essential Commodities Act, 1955, stock limits, imports and the public distribution system). Since 2016 the RBI's Monetary Policy Committee has followed flexible inflation targeting of 4% with a band of plus or minus 2%.

Answer: (B) Increase in the Bank Rate

Raising the Bank Rate makes borrowing dearer and reduces credit and money supply, which curbs inflation. Cutting the Bank Rate or CRR and buying securities in the open market all inject money and would add to inflation.

Answer: (D) All of the above

Monetary policy works through bank credit and money supply, so it is weak against inflation caused by government deficit financing, by supply shortages, or by credit from outside the banking system such as non-bank finance companies. All three limit its effectiveness.

Answer: (D) continuous increase in price level.

Inflation is a sustained, continuous rise in the general price level over time, which erodes the purchasing power of money. A one-time rise in prices is not inflation, rising profits are a possible effect, and deficit financing is one of its causes rather than its definition. In India, headline inflation is measured by the Consumer Price Index (CPI-Combined) compiled by NSO, and under flexible inflation targeting the RBI's Monetary Policy Committee aims at 4% with a band of 2% on either side. Related terms: deflation (falling prices), disinflation (a falling rate of inflation), stagflation (inflation with stagnation).