Saturday, August 22, 2009

Causes of Inflation

One of the most important factors influencing poverty in the country is inflation. Inflation is defined as a situation where general price level is persistently moving upward in a country. In Pakistan the general price level is persistently rising since its establishment. The prices remained volatile during the decade of 1990’s ranging from 5.7 % to 13 % mainly because of declining economic growth, expansionary prices, output set backs, higher taxes and a depreciation of Pakistan rupee. The inflation rate started declining from 1998 onward due to improved supply position of goods and strict budgetary measures. The inflation rate was 5.7 % in 1998-99. It was brought down to 3.6 % in 1999-2000 and further to 3.1 % in 2002-2003. The inflation rate based on CPI (Consumer Price Index) has averaged 4.6 % during 2003-2004. The slight rise in prices was due to increase in price of wheat. The inflation rate reached as high as 9.3% in the year 2004-2005 mainly due to rise in price of wheat and increase in the international oil price.
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 Pakistan’s economy.
Demand-pull inflation is generated when aggregate demand for goods for all purposes-consumption, 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 50’s. 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.
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, non-electrical 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-à-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 increase 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.
The inflation was well under control from the fiscal year 2000 to 2004. However it shoot 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 tones 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.


12 Responses to “Causes of Inflation”

Anonymous said...
June 12, 2012 at 10:03 AM


Anonymous said...
July 1, 2012 at 4:08 PM

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mehwish said...
January 27, 2013 at 12:58 PM

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February 10, 2013 at 5:23 AM

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Faizan Bhatti said...
February 11, 2013 at 5:03 AM

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Anonymous said...
February 18, 2013 at 8:53 PM

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Anonymous said...
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