Liquidity is the biggest enemy of inflation

Inflation is the biggest fear of anyone in any country. The prices of the goods and commodities are not any more same as they were few years back, either it be LPGs, food products, petroleum products or any other products. 

It is stated that the one of reason for the rising prices or inflation could be liquidity of funds in people's hand. The more money people will have they'll tend to create more demand in the market and as the demand will increase it will automatically cause the prices to increase.

Liquidity or the money supply in the market is controlled or increased by the government with the help of monetary policy. 

Monetary policy is adopted by a nation to control the money supply often as an attempt to reduce inflation. 

So to understand that how liquidity is affecting or being the biggest enemy of inflation we'll have to understand how liquidity or the money supply increases in the market. Liquidity is controlled by the help of various tools of monetary policy. Let's discuss them one by one.

Repo rate (Re-purchasing option rate)

Repo Rate is the rate at which the RBI lends the money to the commercial banks or financial institutions in India against securities. The change in repo rate has the great impact in the money supply in the market.

In the layman language it means the rate at which commercial bank takes loan from the central bank (RBI) which generally for the duration of 2-14 days is known as the repo rate.

Reverse Repo Rate

The rate which paid to the commercial banks when they deposit their excess funds with the central bank or when the central bank borrows money from them on a certain rate which is known as Reverse Repo Rate. Generally the surplus amount is given to RBI on this rate.  

Base Rate

The rate at which the commercial banks lends money to the general public is known as the base rate or favourable lending rate.

Base Rate is the minimum interest rate set by the RBI below which Indian Banks are not permitted to lend loans to their customers.

CRR(Cash Reserve Ratio)

The money which RBI reserve from the commercial bank as security deposit in the cash form is known as CRR. Bank does not earn any interest on the amount deposited in CRR with RBI. 

CRR also controls the money flow in the market as if this ratio is increased with the commercial banks more funds will be allocated in the market. 

SLR (Statutory Liquidity Ratio)

The amount which RBI instructs to the commercial banks to maintain a compulsory ratio of the deposits in the form of cash, gold, and other securities in known as SLR. If this ratio is not maintained by the RBI they are imposed with heavy fines. SLR also supports the credit facility of the banks.    

MSF (Marginal Standing Facility)

MSF is a window for banks to borrow from the RBI in an emergency when the inter bank liquidity dries up completely. The MSF or marginal standing rate was launched by RBI while performing the monetary policy.

In layman language When banks takes money from RBI for one day or in emergency RBI imposes the MSF rate instead of Repo Rate. 

Bank Rate

The rate imposed by the central bank when the commercial banks takes loan from them is known as the bank rate which is generally for a duration of more than 14 days. In the event of any fund deficiency occurs a bank can borrow money from the central bank of a country. 

NDTL 

NDTL stands for the net demand and time liability. The funds deposited with the bank by general public which is to be returned with in a specific period of time whenever demanded by the public.  As per RBI commercial banks are required to maintain a average cash balance with RBI and the amount shall not be less than 3% of the total NDTL.

Now lets understand how inflation is affected by liquidity in the market. Inflation is an economic phenomenon that occurs when the prices of goods and services rise, resulting in a decrease in the purchasing power of currency. It is a major concern for governments as it can lead to financial instability and economic recessions. However, there is one factor that is even more detrimental to controlling inflation: liquidity. Let's understand this with an example suppose the money supply in the market is very high and the central bank wants to control this so they will make an increase in the repo rate with led to increase in base rate of the bank to lend loans to people and people or the generally public will take less loans which means they'll have less money in hand to spend and they will tend to save and this will lead to create lesser demand in market will then reduce the prices of goods and services in the market. So we can say that whenever the is more liquidity in the market there will be a rise in the price of goods and services which will lead to create inflation the market. 

Inflation is caused by an increase in the money supply relative to the available goods and services in an economy. When money is easy to come by, people tend to spend more, driving up prices. When liquidity is low, however, money is harder to come by, and people tend to save more, which keeps prices down. Therefore, liquidity is the biggest enemy of inflation, as it restricts the amount of money available to be spent in the economy.

The impact of liquidity on inflation is further exacerbated by government policies. For example, when governments engage in quantitative easing, they increase the money supply in the economy. This increased money supply results in an increase in liquidity, which leads to an increase in prices. Furthermore, when governments increase the interest rate, it reduces liquidity and leads to a decrease in prices.

In conclusion, liquidity is the biggest enemy of inflation. High levels of liquidity in times of economic uncertainty can lead to an increase in prices, resulting in inflation. Conversely, low levels of liquidity can lead to a decrease in prices, resulting in deflation. Governments must be aware of the impact of liquidity on inflation, and must take measures to ensure that liquidity is kept at an optimal level.