FINAL REPORT

SUBJECT
SEMINAR IN FINANCE
TOPIC
INFLACTION
SUBMITTED TO
MAM ANAM ZULFIQUR
SUBMITTED BY
GROUP NO #03

Inflation:
Inflation:
>Inflation is a situation whereby there is a continuous and persistent
rise in the general price level.
>In the state of inflation the prices are rising the value of money is
falling.
> In inflation, too much money chases too few goods.
Is the rate at which the general level of prices
for goods and services is rising and, consequently, the purchasing power
of currency is falling. Central banks attempt to limit inflation, and avoid
deflation, in order to keep the economy running smoothly.

Types of Inflation:
Rate of inflation:
This measurement is influenced by how high or low the prices of goods and
services move throughout the economy

Cost inflation:
Alternative for cost push inflation.

Infant-industry theory:
A theory arguing that governments should play an active role in
protecting fledgling domestic industries from foreign competitors.
Levying high duty rates on imported foreign goods is one method for
protecting an infant industry. This approach is sometimes used
in developing countries to help create a stable local economy with
industries that can eventually compete on an even footing with foreign
firms.

Expectation inflation:

A concept where the rate of inflation becomes

"expected" versus the rate of demand inflation (i.e. inflation based
on economic factors). Expectation inflation acts as a secondary force that
reinforces, or builds upon primary inflation forces such as excess
demand or cost push. This secondary force has an effect on the actual
rate of inflation, as the expectations of the market influence the
economic triggers that drive inflation. Theory dictates that because of
this secondary effect, the rate of inflation can never be held constant
even in a stable economy.

Costs push inflation:

Sustained increase in price of goods and services, caused by the passing off
increased production costs to the consumers by the producers.
Also called cost inflation, it is the opposite of demand pull inflation.

Suppressed inflation:
Existing inflation disguised by government price controls or other
interferences in the economy such as subsidies. Such
suppression, nevertheless, can only be temporary because
no governmental measure can completely contain accelerating inflation in
the long run. Also called repressed inflation.

Creeping inflation:
Circumstance where the inflation of a nation increases gradually, but
continually, over time. This tends to be a typically pattern for
many nations. Although the increase is relatively small in the short-term,
as it continues over time the effect will become greater and greater.

Core inflation:
Persistent and underlying inflation. There is no standard definition
or measure of core inflation. While most economists and policy
makers measure it by consumer price index
(CPI) excluding food and energy prices, others include increases in the
price of basic food items (fish, meat, fruit and vegetables) and/or wage
rates in its computation.

Inflation risk:
Probability of loss resulting from erosion of an income or in
the value of assets due to the rising costs of goods and services.

Demand Pull Inflation:

This is demand side inflation. It simply means that when there is an
increase in aggregate demand. Without any corresponding increase in
aggregate supply the price level will rise.

Structural Inflation
Sometimes prices rise in an expanding economy because the supply
cannot keep up with rising demand because of structural inflexibilities.
This is also called the Structuralist Argument for inflation.

Imported Inflation
In such inflation local governments are helpless; it is due to an
increase in the prices of imported goods. To control it government may
bans the imported items.

Open Inflation
If there is no control over rise in prices, it will be determined by free
forces of demand and supply.

ex-ante & Ex-post Inflation

Ex-ante inflation is the expected inflation and ex-post is the actual
inflation. For example, if people of Pakistan expect an inflation rate of
10% it will Ex-ante inflation but actual inflation is 7 % it will be expost.

Anticipated Inflation

If the actual rate of inflation is perfectly in accordance with the

peoples expectations it is called anticipated inflation .

Unanticipated Inflation
If the actual rate of inflation is not according to the peoples
expectations, it is called unanticipated inflation.

Profit Inflation
Profit inflation is the result of the greed of businessmen. It usually
occurs in such economy, which are dominated by monopolies.

Deficit Inflation
Government has to borrow form banks and non-bank & internal and
external resources in case of deficit financing. It also caused inflation
named as deficit inflation.

Devaluation Inflation
Devaluation also leads to inflation. Devaluation decreases the
purchasing power of our currency that results in inflation.

Ceiling Inflation
Inflation that occurs due to various prices ceiling enforced by
government. Price ceiling are set by government to maintain prices of
certain essential goods at a determined level.

Income Inflation
If there is an increase in income of the people, it will increase the
money supply in the country that leads to income inflation.

DEGREES OF INFLATION:
Inflation contains the following degrees:

Moderate Inflation
When the rate of inflation is very low, say in the range of 1% to 20%, it
is moderate inflation.
If its rate is less than 5 %, then it is creeping inflation.
If its rate is more than 5 %, then it is called trotting inflation.

Galloping Inflation
When the rate of inflation exceeds 20 % it is called galloping
inflation. The upper limit of galloping inflation may roughly be defined
as 1000 %.

Hyper Inflation
If the rate of inflation is above 1000 %, it can be termed as hyperinflation.

CAUSES OF INFLATION IN PAKISTAN

Causes of inflation are of two types:

INCREASE IN DEMAND:
Increase in Money Supply
The major cause of increase in the price level is an increase in money
supply. It may be due to increase in currency or credit money. Increase
in the stock of money induces people to demand more and more of
goods and services.

Increase in Velocity of Money

According to the Fishers Quantity Theory of Money, if there is an
increase in the velocity of circulation of money it also leads to
inflation.

More Investment

Investments also play an important role in producing inflation. At the

moment of investment the economys stock of wealth and money
expands and it result is in inflation.

Non-productive Expenditures
Government of Pakistan has to make a lot of non-productive
expenditures like defence etc. Such unproductive expenditures lead to
the wastage of economys precious resources and also lead to
inflation .

Corruption & Black Money

Corruption and black money leads to increase in aggregate demand, which
is cause of inflation. These evils increase aggregate demand and import
volume.

Deficit Financing
Deficit financing is another cause of inflation. It increases the money
supply and leads to inflation.

Foreign Remittances
Increase in foreign remittances is increasing the money supply in our
country. Increase in money supply leads to inflation .

Foreign Aids
Foreign aids are also a source of mobilization of resources form rich
countries to poor countries. It is also a cause of inflation in Pakistan.

Consumption Trends
Due to demonstration effect people of our country want to copy the
styles of people of rich countries. In this way there is an increase in
consumption trends that leads to inflation.

Population Bomb

Population of Pakistan is increasing day by day. Increasing population

is demanding more and it creates inflation.

DECREASE IN SUPPLY:
Slow Agricultural

Development

Low growth rate of agricultural sector caused in shortage of

productivity. It results in low supply and increase in price level.

Slow Industrial Growth

Our industrial sector is not at developed form due to use of backward
techniques of production. Its less production also creates shortage in
market and caused in inflation.

Increase in Wages & Salaries

Now labour is demanding more wages and salaries. Increase in wages
and salaries leads to increase in cost that increases the prices. On the
other hand due to more wages and salaries there is an increase in
income and it caused in inflation.

Increase in Prices of Imports

Increase in the prices of imports also leads to creation of inflation. If
there is an increase in the prices of oil and other imported raw
material then it will cause to reduction in supply.

Devaluation
The value of our currency is decreased due to devaluation. It makes
imported goods more expensive and it leads to shortage of supply.

Indirect Taxes
The imposition of indirect taxes is a reason for increase in prices.
Sometimes government imposes taxes on some particular

commodities. In this case producer may start to decline the production

of those goods.

MEASURES TO CONTROL THE INFLATION

Following measures are suggested to control high inflation:
1)

Increase in the growth rate of output

2)
Government should control the supply of money through
effective monetary policy
3)

Highly increasing unproductive expenditures must be control

4)
Government should check the corruption first to eliminate the
inflation
5)

Control on population is also necessary to control inflation

6)

Reduction in budget surplus

7)

Reduction in monetary expansion

8)

Effective tax system will be helpful to control the inflation

9)

Improvement in balance of payment

10) Developments of agricultural and industrial sector will helps to

control the inflation.

EFFECTS OF INFLATION
GOOD EFFECTS
1)

There is increase in production due to inflation.

2)

Inflation increases the employment opportunities in the country.

3)

Inflation enhances the process of economic development.

4)

There is more investment in country at the time of inflation.

5) Inflation increases the economic activities that may cause

to inventions and innovations.
6)
Profit of the producers also increases when there is normal
inflation.

BAD EFFECTS
1)

It is a huge problem for employees, taking fixed salaries.

2)

It generates unfair distribution of income and wealth.

3)

Inflation reduces the saving of the population.

4)

It is a cause of unfavorable balance of trade and payment.

5)

Inflation increases the rate of interest.

6)

It creates a lot of social evils.

7)

It is difficult for consumers to purchases more goods.

8)

It generates very bad effects on the poor labor force.

9)
Inflation reduces the living standard and purchasing power of
people.
10) It is harmful for creditors.
11) Inflation reduces the purchasing power.

Consumer price index (CPI)

A measure of changes in the purchasing-power of a currency and the rate of inflation. The
consumer
price
index
expresses
the current prices of
a basket
of
goods and services in terms of the prices during the same period in a previous year, to show
effect of inflation on purchasing power. It is one of the best known lagging indicators. See
also producer price index.

What Is CPI & Why Is It Important?

One of the most watched economic indicators is the Consumer Price

Index. The CPI is calculated by the Bureau of Labor Statistics, which is
part of the Department of Labor. The CPI is updated and published on a
monthly, quarterly and annual basis. The CPI, also known as the cost of
living index, measures the cost of eight specific consumer expenditure
groups. This information is then used to determine whether the inflation
rate is rising or falling.

The CPI Price Basket

Eight major consumer expenditure groups make up the CPI price basket:
Food and Beverage, Housing, Apparel, Transportation, Medical Care,
Recreation, Education and Communication, and Other Goods and
Services. The Other Goods and Services group includes haircuts, funeral
expenses and tobacco and related product purchases. Each group
contains a variety of goods and services purchased by consumers for
personal use. Also included in the CPI basket are government charges for
water and sewer usage, automobile registration fees and sales and excise
taxes incurred while purchasing consumer goods and services.

CPI as an Inflation Indicator

Government agencies, businesses and consumers are concerned with
inflation. The CPI acts as a barometer of the present inflation rate. The
federal government uses CPI inflation information to implement fiscal
policy changes. One way the Federal Reserve Board can slow inflation is
by lowering the federal funds rate. The federal funds rate is the interest
rate banks charge each other for interbank loans. This lower interest rate
is passed on to consumers and slows the inflation rate.

CPI as an Economic Series Deflator

The CPI is used to determine the deflated value of an economic series
and the dollars purchasing power. The dollars of an economic series such
as retail sales, or hourly and weekly earnings are recalculated into
inflation-free dollars so that prices can be compared against previous
time periods. Because the CPI uses deflated dollars, its also very useful
in measuring the dollars purchasing power. If the CPI basket prices

decrease, the dollars purchasing power increases because it takes less

money to buy the same goods.

CPI as a Dollar Value Adjuster

The US government uses CPI economic series deflator information to
determine if a cost of living increase is warranted. The CPI affects how
much Social Security payments, food stamp allotments and military
retiree benefits are increased. Its also used to adjust the cost of school
lunch programs and union collective bargaining benefits. The CPI dollar
value adjustment prevents taxes from being increased solely due to
inflation. Businesses also use this information to help determine if
employees should receive a cost of living wage increase.

Cost-Push Inflation
Aggregate supply is the total volume of goods and services produced by
an economy at a given price level. When there is a decrease in the
aggregate supply of goods and services stemming from an increase in
the cost of production, we have cost-push inflation. Cost-push inflation
basically means that prices have been "pushed up" by increases in costs
of any of the four factors of production (labor, capital, land or
entrepreneurship) when companies are already running at full production
capacity. With higher production costs and productivity maximized,
companies cannot maintain profit margins by producing the same
amounts of goods and services. As a result, the increased costs are
passed on to consumers, causing a rise in the general price level
(inflation).

Demand-Pull Inflation
Demand-pull inflation occurs when there is an increase in aggregate
demand, categorized by the four sections of the macroeconomic:
households, businesses, governments and foreign buyers. When these
four sectors concurrently want to purchase more output than the
economy can produce, they compete to purchase limited amounts of
goods and services. Buyers in essence "bid prices up", again, causing
inflation. This excessive demand, also referred to as "too much money
chasing too few goods", usually occurs in an expanding economy.

Deflation

Is a general decline in prices, often caused by a reduction in the supply of

money or credit?
When the overall price level decreases so that inflation rate becomes
negative, it is called deflation. It is the opposite of the often-encountered
inflation.
Deflation is the reduction of prices of goods, and although deflation may
seem like a good thing when youre standing at the checkout counter, its
not. Rather, deflation is an indication that economic conditions are
deteriorating. Deflation is usually associated with
significant unemployment, which is only corrected after wages drop
considerably. Furthermore, businesses profits drop significantly during
periods of deflation, making it more difficult to raise additional capital to
expand and develop new technologies

Consequences of deflation
Consistent fall in the general price level in the economy (deflation) might
not be good news for the economy. Long term deflation will lead to:

Cyclical unemployment:
Deflation usually happens to due to a fall in Aggregate Demand in the
economy. This will lead to businesses cutting the output levels which will
result in retrenchment/laying off of workers. Moreover, if consumers delay
spending in anticipation of falling prices economic activity
falls, unemployment increases.

Bankruptcies:
As the value of money is increasing, it becomes difficult for debtors to
repay the load. Moreover, during deflation firms will be having lower
profits due to falling prices and will find it difficult to meet their liabilities.
This might lead to greater number of bankruptcies. Businesses see profits

fall; as they do so dividends and investment returns fall and so

share prices fall.

Deflationary spiral:
Consistent fall in prices may trigger deflationary spiral. As firms make
less profit, this leads to less profits, they might not be willing or able to
invest which will have negative implications on the economic growth.
Moreover, as firms cut cost by lay off workers, there is less income for the
households and the aggregate demand might fall. Due to a fall in
consumer and business confidence the economy might fall into a
deflationary spiral.

Global financial crisis of 20082009

The global financial crisis of 20082009 is an ongoing major financial
crisis. It became prominently visible in September 2008 with the failure,
merger, or conservatorship of several large United States-based financial
firms. The underlying causes leading to the crisis had been reported in
business journals for many months before September, with commentary
about the financial stability of leading U.S. and European investment
banks, insurance firms and mortgage banks consequent to the subprime
mortgage crisis. Beginning with failures of large financial institutions in
the United States, it rapidly evolved into a global credit crisis, deflation
and sharp reductions in shipping resulting in a number of European bank
failures and declines in various stock indexes, and large reductions in the
market value of equities (stock) and commodities worldwide. The credit
crisis was exacerbated by Section 128 of the Emergency Economic
Stabilization Act of 2008 which allowed the Federal Reserve System (Fed)
to pay interest on excess reserve requirement balances held on deposit
from banks, removing the longstanding incentive for banks to extend
credit instead of hoard cash on deposit with the Fed. The crisis led to a
liquidity problem and the de-leveraging of financial institutions especially
in the United States and Europe, which further accelerated the liquidity
crisis, and a decrease in international shipping and commerce. World
political leaders and national ministers of finance and central bank
directors have coordinated their efforts to reduce fears but the crisis is
ongoing and continues to change, evolving at the close of October into a
currency crisis with investors transferring vast capital resources into
stronger currencies such as the yen, the dollar and the Swiss franc,

leading many emergent economies to seek aid from the International

Monetary Fund. The crisis was triggered by the subprime mortgage crisis
and is an acute phase of the financial crisis of 20072009.

Prelude (early September, 2008)

The subprime mortgage crisis reached a critical stage during the first
week of September 2008, characterized by severely contracted liquidity
in the global credit markets and insolvency threats to investment banks
and other institutions. Reserve balances from banks in the Federal
Reserve System began increasing over required levels of about $10
billion at the beginning of September 2008, just after the Democratic and
Republican national conventions, and just before the stock market crash
and presidential debates. Beginning October 6, Section 128 of the
Emergency Economic Stabilization Act of 2008 allowed the Federal
Reserve System to pay interest on the excess balances, producing further
pressure on international credit markets. Excess on reserve balances
topped $870 billion by the end of the second week of January 2009. In
comparison, the increase in reserve balances reached only $65 billion
after September 11, 2001 before falling back to normal levels within a
month. House Representative Paul E. Kanjorski claimed in a January 27,
2009 interview with CSPAN that there was an "electronic run on the
banks" during the second week of September, 2008. According to the
testimony $550 Billion were withdrawn from money market accounts in
the U.S. within a two hour time- span. Policymakers responded by
guaranteeing up to $250,000 in money market deposits through the
FDIC. Representative Kanjorski claims that if these steps had not been
taken, the U.S. would have lost all its wealth within twenty-four hours.

Government takeover of home mortgage lenders

The United States director of the Federal Housing Finance Agency (FHFA),
James B. Lockhart III, on September 7, 2008 announced his decision to
place two United States Government sponsored enterprises (GSEs),
Fannie Mae (Federal National Mortgage Association) and Freddie Mac
(Federal Home Loan Mortgage Corporation), into conservatorship run by
FHFA. United States Treasury Secretary Henry Paulson, at the same press
conference stated that placing the two GSEs into conservatorship was a
decision he fully supported, and said that he advised "that
conservatorship was the only form in which I would commit taxpayer

money to the GSEs." He further said that "I attribute the need for today's
action primarily to the inherent conflict and flawed business model
embedded in the GSE structure, and to the ongoing housing correction."
The same day, Federal Reserve Bank Chairman Ben Bernanke stated in
support: "I strongly endorse both the decision by FHFA Director Lockhart
to place Fannie Mae and Freddie Mac into conservatorship and the actions
taken by Treasury Secretary Paulson to ensure the financial soundness of
those two companies."

Major financial firm crisis

On Sunday, September 14, it was announced that Lehman Brothers
would file for bankruptcy after the Federal Reserve Bank declined to
participate in creating a financial support facility for Lehman Brothers.
The significance of the Lehman Brothers bankruptcy is disputed with
some assigning it a pivotal role in the unfolding of subsequent events.
The principals involved, Ben Bernanke and Henry Paulson, dispute this
view, citing a volume of toxic assets at Lehman which made a rescue
impossible. Immediately following the bankruptcy, JPMorgan Chase
provided the broker dealer unit of Lehman Brothers with $138 billion to
"settle securities transactions with customers of Lehman and its
clearance parties" according to a statement made in a New York City
Bankruptcy court filing. The same day, the sale of Merrill Lynch to Bank of
America was announced. The beginning of the week was marked by
extreme instability in global stock markets, with dramatic drops in market
values on Monday, September 15, and Wednesday, September 17. On
September 16, the large insurer American International Group (AIG), a
significant participant in the credit default swaps markets suffered a
liquidity crisis following the downgrade of its credit rating. The Federal
Reserve, at AIG's request, and after AIG has shown that it could not find
lenders willing to save it from insolvency, created a credit facility for up
to US$85 billion in exchange for a 79.9% equity interest, and the right to
suspend dividends to previously issued common and preferred stock.

Money market funds insurance and short sales

prohibitions
On September 16, the Reserve Primary Fund, a large money market
mutual fund, lowered its share price below $1 because of exposure to
Lehman debt securities. This resulted in demands from investors to

return their funds as the financial crisis mounted. By the morning of

September 18, money market sell orders from institutional investors
totalled $0.5 trillion, out of a total market capitalization of $4 trillion, but
a $105 billion liquidity injection from the Federal Reserve averted an
immediate collapse. On September 19 the U.S. Treasury offered
temporary insurance (akin to FDIC insurance of bank accounts) to money
market funds. Toward the end of the week, short selling of financial
stocks was suspended by the Financial Services Authority in the United
Kingdom and by the Securities and Exchange Commission in the United
States. Similar measures were taken by authorities in other countries.
Some restoration of market confidence occurred with the publicity
surrounding efforts of the Treasury and the Securities Exchange
Commission.

Troubled Asset Relief Program

On September 19, 2008 a plan intended to ameliorate the difficulties
caused by the subprime mortgage crisis was proposed by the Secretary
of the Treasury, Henry Paulson. He proposed a Troubled Assets Relief
Program (TARP), later incorporated into the Emergency Economic
Stabilization Act, which would permit the United States government to
purchase illiquid assets, informally termed toxic assets, from financial
institutions. The value of the securities is extremely difficult to determine.
Consultations between the Secretary of the Treasury, the Chairman of the
Federal Reserve, and the Chairman of the U.S. Securities and Exchange
Commission, Congressional leaders and the President of the United
States moved forward plans to advance a comprehensive solution to the
problems created by illiquid mortgage-backed securities. At the close of
the week the Secretary of the Treasury and President Bush announced a
proposal for the federal government to buy up to US$700 billion of illiquid
mortgage backed securities with the intent to increase the liquidity of the
secondary mortgage markets and reduce potential losses encountered by
financial institutions owning the securities. The draft proposal of the plan
was received favorably by investors in the stock market. Details of the
bailout remained to be acted upon by Congress.