Inflation

Inflation is defined as a sustained increase in the general level of prices for goods and services. It is measured as an annual percentage increase. As inflation rises, every dollar you own buys a smaller percentage of a good or service. The value of a dollar does not stay constant when there is inflation. The value of a dollar is observed in terms of purchasing power, which is the real, tangible goods that money can buy. When inflation goes up, there is a decline in the purchasing power of money. For example, if the inflation rate is 2% annually, then theoretically a $1 pack of gum will cost $1.02 in a year. After inflation, your dollar can't buy the same goods it could beforehand. Introduction:Collective increase in the supply of money, in money incomes, or in prices refers to inflation. Inflation is generally thought of as an undue rise in the general level of prices. Definition:Inflation is a situation whereby there is a continuous and persistent rise in the general price level. According to Meyer: An increase in the prices that occurs after full employment has been attained. According to Ackley: A persistent and appreciable rise in the general level or average of prices. According to Crowther: In the state of inflation the prices are rising i. e., the value of money is falling. According to Coulbourn: In inflation, too much money chases too few goods.

Inflation in Pakistan
Today, inflation is one of the serious problems faced by Pakistan. Rate of inflation in Pakistan is very high. According to economic survey 2009-10, its rate is 13.3 %, while it was 22.3 % in last fiscal year. According to ESP rate of inflation (CPI) is 14.1%.

Table of Inflation Rates by Month and Year (1999-2013)

Year 2013 2012 2011 2010 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 1999 Jan 1.6 2.9 1.6 2.6 0 4.3 2.1 4 3 1.9 2.6 1.1 3.7 2.7 1.7 Feb 2.9 2.1 2.1 0.2 4 2.4 3.6 3 1.7 3 1.1 3.5 3.2 1.6 Mar 2.7 2.7 2.3 -0.4 4 2.8 3.4 3.1 1.7 3 1.5 2.9 3.8 1.7 Apr 2.3 3.2 2.2 -0.7 3.9 2.6 3.5 3.5 2.3 2.2 1.6 3.3 3.1 2.3 May 1.7 3.6 2.0 -1.3 4.2 2.7 4.2 2.8 3.1 2.1 1.2 3.6 3.2 2.1 Jun 1.7 3.6 1.1 -1.4 5.0 2.7 4.3 2.5 3.3 2.1 1.1 3.2 3.7 2 Jul 1.4 3.6 1.2 -2.1 5.6 2.4 4.1 3.2 3 2.1 1.5 2.7 3.7 2.1 Aug 1.7 3.8 1.1 -1.5 5.4 2 3.8 3.6 2.7 2.2 1.8 2.7 3.4 2.3 Sep 2.0 3.9 1.1 -1.3 4.9 2.8 2.1 4.7 2.5 2.3 1.5 2.6 3.5 2.6 Oct 2.2 3.5 1.2 -0.2 3.7 3.5 1.3 4.3 3.2 2 2 2.1 3.4 2.6 Nov 1.8 3.4 1.1 1.8 1.1 4.3 2 3.5 3.5 1.8 2.2 1.9 3.4 2.6 Dec 1.7 3.0 1.5 2.7 0.1 4.1 2.5 3.4 3.3 1.9 2.4 1.6 3.4 2.7 Ave 2.1 3.2 1.6 -0.4 3.8 2.8 3.2 3.4 2.7 2.3 1.6 2.8 3.4 2.2

GRAPHICAL ANALYSIS OF INFLATION FROM 2008 TO 2012 USING CPI The inflation rate in Pakistan was last reported at 10.8 percent in March of 2012. From 2003 until 2010, the average inflation rate in Pakistan was 10.15 percent reaching an historical high of 25.33 percent in August of 2008 and a record low of 1.41 percent in July of 2003.

CAUSES OF INFLATION IN PAKISTAN

The causes of general rise in prices are usually grouped under the following two main heads. 1. Demand-pull inflation and (2) Cost-push-inflation. These two types of inflation are now discussed in the context of Pakistans economy.

1. DEMAND-PULL INFLATION Demand-pull inflation is generated when aggregate demand for goods for all purposesconsumption, investment and government exceeds the supply of goods at current prices. The main factors which have led to demand induced inflation in Pakistan are as follows. (i) Demand for non-development expenditures: The elected and non-elected governments in Pakistan since 1947 have not been able to curb the non-development expenditures. The lavish expenditures by the elected representatives and the government functionaries have contributed to the inflationary rise in the general prices. (ii) Rapid monetary expansion: During the last three years the growth in monetary assets has outstripped the rise in nominal GDP. The easy monetary policy adopted to kick start the stagnant economy has led to the rise in general price level. (iii) Deficit Financing: Due to lack of resources for economic development, the government has been resorting to deficit financing (bank borrowing, creation of new currency) over the years. The excessive growth in money supply compared to increase in output has resulted in inflation. (iv) Increase in Workers remittances: During the last three years there is a rapid increase in the flow of workers remittances in the country. During the year 2001-02 the workers remittance were $2.389 billion which now in the year 2004-05 have crossed $3.90 billion dollars. The workers remittances no doubt a boon for the country, has also resulted in the expansion in aggregate demand for goods and so a factor in the general rise in prices. (v) Foreign Economic assistance: For rapid economic development, Pakistan has been receiving foreign and since early 50s. The foreign debt outstanding is 36.6 billion dollars by 2005. The tied and untied aid is mostly invested in the projects having long gestation. The output of goods, therefore does not increase correspondingly with the rise in income. Foreign economic assistance is thus also a contributory factor in pulling up the general level of prices in the country. (vi) Consumption habits: Pakistanis living in Urban and rural areas are mostly send thrift. They are proud of spending money on the goods which are used by the people in the advanced countries of the world. The increased expenditure on clothes, foods, cosmetics etc. have added much to the inflationary pressure in the country. (vii) Construction of houses: Since 1970 people are spending their savings mostly on the purchase of land and construction of houses. The unproductive expenditure on the construction of houses, plazas etc. has also contributed to the rising trend in prices. (viii) Excessive speculation and hoarding: The investor class since the nationalization of industries is generally shy of investing money in capital intensive projects. They are mostly spending their resources on speculation and hoarding of goods. The abrupt rise I demand of goods also results in the rise of price level of goods.

(ix) Increase in Wages: The rise in wages, salaries, dearness allowances, bonuses etc. in the annual budget increase the purchasing power of the employees. With the increase in the disposable income of the workers, the prices of the commodities go up. The workers gain press for higher wages. The wages and prices thus chess each other at a very rapid speed and have accelerated the trend of price rise in the country. (x) Population explosion: The population is increasing at the rate of about 1.9% in Pakistan, the pressure of population has increased the aggregate demand for commodities thus pulling up the general level of prices in the country. (xi) Black Money: Black money is the unaccounted money receipts. It is generated through smuggling, tax evasion, price control etc. It is estimated that annual generation of black money is about 25% of GNP of the country. This huge amount pushes up the prices of land, houses, cars, air conditioners and other expensive items.

2. COST-PUSH INFLATION The rise in the general price level is also caused by the rising costs of the factors of production; it is called cost push inflation. In Pakistan the cost push inflation has occurred in the following ways. (i) Increase in Wages: In Pakistan one of the factors leading to cost-push inflation in the rise in wage not backed by increase in productivity. The compensatory wage increase and the rise in prices are chasing each other at quite a rapid speed causing personal rise in the level of prices. (ii) Rising prices of imported goods: The import prices of POL chemicals, fertilizers, nonelectrical machinery etc have gone up in the world market. The cost and so the price of commodities using the imported items has gone up in the country. (iii) Increase in Indirect taxes: For increasing the revenue the Government is heavily relying on indirect taxes. The increase in the indirect taxes every year has given the general price level an inflationary push. (iv) Depreciation of Rupee: The Pakistani rupee is depreciating vis--vis the US dollar. The repeated and higher devaluations of Pakistani rupee has increased the cost and prices of imported goods. Depreciation of the currency thus is an important factor for the rise in the average level of prices in Pakistan. (v) Rise in POL, Gas, and Excise Duty: The multiplier effect of the rise in POL, gas prices, and levying of excise duty, sales tax on a number of items has greatly contributed to the cost push effect.

(vi) Sick Industrial Units: The increase in number of sick industrial units, fall in industrial production due to strikes, electricity breakdown etc cause decrease in production and lead to higher cost, thus pushing up inflationary pressure. (vii) Increase in Utility Tariffs, excise duty: The government in the budgets considerably increases the rates of sales tax, excise duty on a large number of items. A rise in utility tariffs, has also kicked a new round of inflation in the country. (viii) Rise in support price of agriculture crops: The Government raises the support prices of cotton, wheat, sugar cane to protect the interests of farmers. This also has an inflationary impact on the currency.

EFFECTS OF INFLATION
Most effects of inflation are negative, and can hurt individuals and companies alike, below is a list of negative and Positive effects of inflation.

1. NEGATIVE EFFECTS Hoarding (people will try to get rid of cash before it is devalued, by hoarding food and other commodities creating shortages of the hoarded objects). Distortion of relative prices (usually the prices of goods go higher, especially the prices of commodities). Increased risk - Higher uncertainties (uncertainties in business always exist, but with inflation risks are very high, because of the instability of prices). Income diffusion effect (which is basically an operation of income redistribution). Existing creditors will be hurt (because the value of the money they will receive from their borrowers later will be lower than the money they gave before). Fixed income recipients will be hurt (because while inflation increases, their income doesnt increase, and therefore their income will have less value over time). Increased consumption ratio at the early stages of inflation (people will be consuming more because money is more abundant and its value is not lowered yet). Lowers national saving (when there is a high inflation, saving money would mean watching your cash decrease in value day after day, so people tend to spend the cash on something else). Illusions of making profits (companies will think they were making profits while in reality theyre losing money if they dont take into consideration the inflation rate when calculating profits).

Causes an increase in tax bracket (people will be taxed a higher percentage if their income increases following an inflation increase). Causes mal-investment (in inflation times, the data given about an investment is often deceptive and unreliable, therefore causing losses in investments).

2. POSITIVE EFFECTS It can benefit the inflators (those responsible for the inflation) It can benefit early and first recipients of the inflated money (because the negative effects of inflation are not there yet). It can benefit the cartels (it benefits big cartels, destroys small sellers, and can cause price control set by the cartels for their own benefits). It might relatively benefit borrowers who will have to pay the same amount of money they borrowed (+ fixed interests), but the inflation could be higher than the interests; therefore they will be paying less money back. (Example, you borrowed $1000 in 2005 with a 5% fixed interest rate and you paid it back in full in 2007, lets suppose the inflation rate for 2005, 2006 and 2007 has been 15%, you were charged %5 of interests, but in reality, you were earning %10 of interests, because 15% (inflation rate) 5% (interests) = %10 profit, which means you have paid only 70% of the real value in the 3 years. Many economists favor a low steady rate of inflation, low (as opposed to zero or negative)inflation may reduce the severity of economic recessions by enabling the labor market to adjust more quickly in a downturn, and reducing the risk that a liquidity trap prevents monetary policy from stabilizing the economy. The task of keeping the rate of inflation low and stable is usually given to monetary authorities. Generally, these monetary authorities are the central banks that control the size of the money supply through the setting of interest rates, through open market operations, and through the setting of banking reserve requirements. Tobin effect argues that: a moderate level of inflation can increase investment in an economy leading to faster growth or at least higher steady state level of income. This is due to the fact that inflation lowers the return on monetary assets relative to real assets, such as physical capital. To avoid inflation, investors would switch from holding their assets as money (or a similar, susceptible to inflation, form) to investing in real capital projects. The first three effects are only positive to a few elite, and therefore might not be consider d positive by the general public.

MEASURE TAKEN TO CONTROL THE INFLATION IN PAKISTAN

The inflation was well under control from the fiscal year 2000 to 2004. However it shoots up to 9.3% in the year 2005 mainly due to the rise in support price of wheat and a surge in

international price of oil. The Government of Pakistan being well aware of the adverse effect of inflation is taking following measures to bring down the inflationary pressure in the economy. 1. Increase in the supply of essential goods: The Government is regularly monitoring the domestic stock of essential goods and their prices in the market. The supply of essential goods is being improved through the import of these commodities. 2. Establishment of high level committee: A high level committee is established which is to monitor the price situation on daily basis. It will keep a close watch on the supply and demand conditions of essential goods. 3. Rise in the price of oil: During the year 2004-05 there was a rapid increase in the oil prices at international level. The Government has only partly shifted the burden of rise in oil prices to the consumers. 4. Tightening Monetary policy: In the past three years there is a rising level of economic activity in the country. The state Bank of Pakistan is effectively using monetary policy to put down pressure on general price level. 5. Import of Wheat: There is a record production of wheat of 21.1 million tons in 2004-05. The Government is building up reserves of wheat to stabilize prices of wheat in the market by import of wheat also. 6. Supply of flour and other items of utility through Utility Stores: The Government is supplying flour, sugar on reduced prices to the in the country through the utility stores. 7. A deep drop of the exchange rate can also result in inflation, as governments will have to deal with differences in the import/export level. FEDERAL TAXES Finally, inflation can be caused by federal taxes put on consumer products such as cigarettes or fuel. As the taxes rise, suppliers often pass on the burden to the consumer; the catch, however, is that once prices have increased, they rarely go back, even if the taxes are later reduced. For example arise in the rate of excise duty on alcohol and cigarettes, an increase in fuel duties or perhaps a rise in the standard rate of Value Added Tax or an extension to the range of products to which VAT is applied. These taxes are levied on producers (suppliers) who, depending on the price elasticity of demand and supply for their products, can opt to pass on the burden of the tax onto consumers. For example, if the government was to choose to levy a new tax on aviation fuel, then this would contribute to a rise in cost-push inflation.

RECOMMENDATIONS
Inflation is one of the obstacles on the way of development. In Pakistan, it has squeezed the major part of the population. It needs to be controlled by strategic planning. Domestic production should be encouraged instead of imports. Investment should be given preference in consumer goods instead of luxuries. Agriculture sector should be given subsidies. Foreign investment should be attracted and developed countries should be requested for financial and managerial assistance. Steps should be taken to reduce our government luxury expenses, to reassess the complete system of direct and indirect taxes, to increase the production of food and industry and to reduce unemployment. And lastly a strong monitoring system should be established on different levels in order to have a sound evaluation of the process at every stage. Pakistan should become self-reliant. Well there is no such hope that inflation will ever be reduced in Pakistan but still we can control it by carrying out some measures and precautionary steps. As the Government carry out the printing of the new notes it also increases the salaries of the workers as well. If the Government control themselves with the stoppage of the new currency notes then it might be possible that the inflation would stop. Moreover, as we mentioned that the shop owners take the advantage of the factory strikes but the people of Pakistan should be educated enough for knowing the existing market rates. 1. Very little can be done to control the international inflation in prices, all a country can do is, become more self reliant and less dependent on imports. E.g. increase crude oil prices are something which effects every country in the world, but cannot do much to control it. But it can make it industry less dependent on oil and more dependent on alternate sources e.g. Natural gas (who's prices are not linked oil prices), electricity (mainly hydel and coal based and not oil produced) 2. If supply is less then demand then price of goods will rise...There is little can be done control that it, in a free market economy. But sometimes traders resort to hoarding (illegal accumulation) of goods to earn more profit by creating artificial scarcity in the market .As is happening in Pakistan's sugar industry, and wheat crop these days. Sometimes trades hold back good from local market to sell them in international markets (to earn more profit), lead to scarcity of goods in the country, which in turn can lead to importing of the same goods from outside at international prices. This practice can be checked by the govt, if it wants to. 3. In last two year Pakistan govt (SBP) has printed, a huge amount of money (I do not remember the exact amount) to fund its Budget deficit. This is the main reason for increase in inflation in Pakistan.