2  BIS Review 55/2007  Who should take the blame for inflation? It is ironical that practically everyone in the society should take blame for a continuously high inflation in an economy. This is because everyone, even in a very little measure, would have contributed to facilitate inflation to raise its ugly head. It happens when people of a country believe that they can have a higher standard of living without working harder or producing more. Inflation in the long run is directly related to the amount of money which people would have for buying goods and services. When that quantity of money is in far excess of the quantity of goods and services, the general price level has to move up in order to facilitate the required volume of transactions. Hence, the magic solution for keeping inflation in check has been the production of money exactly in line with the production of goods and services in the economy. Any violation of this golden rule, for whatever the justifiable reason, would pave the way for the long run inflation to peep into the system. In this context, the Central Bank has an inalienable responsibility to take all the measures necessary to curb long term inflation. The role of the Central Bank The Central Bank takes monetary policy measures to keep the total volume of money in line with the total production and the volume of transactions in the economy.
Hence, the farmers would concentrate on producing more of carrots and less of cabbages. But, when an economy is hit by inflation, all the prices would rise simultaneously, so both carrots and cabbages seem to be equally profitable. This would confuse the producers who would now be unable to make any choice between the two products. Hence, the much desired relative price change does not occur, when an economy has been hit by inflation. Instead, the absolute prices start to change and such changes do not provide the price signals for allocating resources. Fifth, continued inflation distorts the balance sheets of companies, especially the balance sheets of financial institutions. Companies may record profits in nominal terms, but a large part of such profits are eroded in real terms by inflation. When profits are adjusted for inflation, companies would find that their performance has not been so spectacular as has been depicted by the amount of rupees they have earned. In fact, their real position has pushed them backward to a lower level. Sixth, inflation very forcefully hits the vulnerable groups with a weaker bargaining power. Such categories include housewives, students, pensioners and workers whose salaries are not linked to inflation. It would lead to continuous agitation by these groups creating social and political dissension. The country, instead of using its resources for investing in long term growth generating projects, would have to spend its energy and resources for solving such social issues. Thus, inflation is the unrivalled public enemy number one.