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Economic, Inflation

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Inflation
Definition
“Too much money in circulation causes the money to lose value”-this is the true meaning of inflation. The popular opinion about the costs of inflation is that inflation makes everyone worse off by reducing the purchasing power of incomes, eroding living standards and adding, in many ways, to life’s uncertainties. In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time. Inflation refers to a rise in prices that causes the purchasing power of a nation to fall.

Inflation is a normal economic development as long as the annual percentage remains low; once the percentage rises over a pre-determined level, it is considered an inflation crisis. In another word “Inflation means that your money won’t buy as much today as you could yesterday”. Definition of Inflation rate (consumer prices)

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This entry furnishes the annual percent change in consumer prices compared
with the previous year’s consumer prices.

The inflation rate is the percentage rate of change of a price index over time.

Effect on the economy

General Effect
An increase in the general level of prices implies a decrease in the purchasing power of the currency. That is, when the general level of prices rises, each monetary unit buys fewer goods and services. Increases in the price level (inflation) erode the real value of money (the functional currency) and other items with an underlying monetary nature (e.g. loans and bonds). For example if one takes a loan where the stated interest rate is 6% and the inflation rate is at 3%, the real interest rate that one are paying for the loan is 3%. It would also hold true that if one had a loan at a fixed interest rate of 6% and the inflation rate jumped to 20%one would have a real interest rate of -14%.

Negative Effect
High or unpredictable inflation rates are regarded as harmful to an overall economy. They add inefficiencies in the market, and make it difficult for companies to budget or plan long-term. Inflation can act as a drag on productivity as companies are forced to shift resources away from products and services in order to focus on profit and losses from currency inflation. Uncertainty about the future purchasing power of money discourages investment and saving and inflation can impose hidden tax increases. In case of international trade, ‘Higher inflation in one economy than another will cause the first economy’s exports to become more expensive and affect the balance of trade’

Positive Effect
Positive effects include ensuring central banks can adjust nominal interest rates (intended to mitigate recessions), and encouraging investment in non-monetary capital projects. It puts impact on Labor-market adjustments, Room to maneuver, Mundell-Tobin effect, Instability with Deflation etc

Causes behind inflation
In developing countries, in contrast, inflation is not a purely monetary phenomenon, but is often linked with fiscal imbalances and deficiencies in sound internal economic policies. Beside, factors typically related to fiscal imbalances such as higher money growth and exchange rate depreciation arising from a balance of payments crisis dominate the inflation process in developing countries. There were different schools of thought as to the causes of inflation. Most can be divided into two broad areas: 1. Quality theories of inflation

2. Quantity theories of inflation.
The quality theory of inflation rests on the expectation of a seller accepting currency to be able to exchange that currency at a later time for goods that are desirable as a buyer.

The quantity theory of inflation rests on the quantity equation of money that relates the money supply, its velocity, and the nominal value of exchanges. Adam Smith and David Hume proposed a quantity theory of inflation for money, and a quality theory of inflation for production After analyzing two theories of causes we have got here some physical cause to face which cover both theories depending on a number of factors. These are given below-

Excess of money

Inflation can happen when governments print an excess of money to deal with a crisis. As a result, prices end up rising at an extremely high speed to keep up with the currency surplus. This is called the demand-pull, in which prices are forced upwards because of a high demand.

Rise in production cost

Another common cause of inflation is a rise in production costs, which leads to an increase in the price of the final product. For example, if raw materials increase in price, this leads to the cost of production increasing, which in turn leads to the company increasing prices to maintain steady profits? Rising labor costs can also lead to inflation. As workers demand wage increases, companies usually chose to pass on those costs to their customers.

International lending & national debt
Inflation can also be caused by international lending and national debts. As nations borrow money, they have to deal with interests, which in the end cause prices to rise as a way of keeping up with their debts. 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.

Government 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.

War

Wars are often cause for inflation, as governments must both recoup the money spent and repay the funds borrowed from the central bank. War often affects everything from international trading to labor costs to product demand, so in the end it always produces a rise in prices.

Lists of Inflation Rate from 1998-2011

Country
1998
2000
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
Bangladesh
9
5.8
3.1
5.6
6
7
7.2
9.1
8.9
5.4
8.1
10.7

Graph of Inflation Rate in Bangladesh

Historical Trend Analysis
The government introduced policy and institutional reforms encompassing the fiscal, financial, exchange rate, trade and industry, public resource management and public enterprise sectors. But some of those measures were not strongly pursued and some of the intended structural reforms were postponed. Monetary control in the initial years had a positive impact on the control of inflation. The regarded decision are taken below-

To increase investible funds with the banks, the minimum cash reserve requirement and statutory liquidity requirement were reduced gradually from 8 and 23 percent respectively on 25 April 1991 to 5 and 20 per cent respectively. This decision has reduced the inflation rate. In 1991 the lending rate was 14.99 which was high during 1992 but then it started to be reduced at 14.39 (1993) and 12.22 at 1995. With the flexible use of the monetary instruments, broad money growth (Money Supply) was brought down from high rates of growth (14.1 percent) in the mid-1992to 10.6 per cent in June 1993 to reduce the rate of inflation. In the year 1995 government was thinking to increase the money supply which was brought to 16 percent for that reason inflation rate increased. In the year 1995 government was thinking to increase the total domestic credit which was brought to 17.6 percent from 4.9 percent (1994). For this reason the inflation rate increased. In the year 1995 government liberalized Credit to the private sectors in fiscal year1995 by reducing lending rates including those in the three selected sectors of agriculture, exports, and small and cottage Industries had to be restrained due to the rise in price levels.

For this reason inflation rate has increased With a view to ensuring an adequate flow of finance to productive sectors and to boosting economic activity, Bank rate was gradually lowered from 9.8 per cent on30 June 1990 to 5.5 per cent on 3 March 1994 to control the inflation rate. On 24 March 1994 Bangladesh accepted the Article VIII obligations of the International Monetary Fund, a commitment to declare its currency convertible for current account transactions and liberalize exchange transactions on current account. Foreign exchange controls, which had constrained transactions for a longtime, were lifted for the majority of current account transactions. An interbank foreign exchange market has been established. The exchange rate policy is being managed flexibly so as to avoid appreciation of the real exchange rate and to maintain macroeconomic stability. Moderate economic growth and modest change in the wage index contributed to the relatively low rate of inflation (i.e., lower than 5 per cent) in 1990-1994. Higher money supply growth and lower deposit rate in FY95 contributed to the comparatively higher inflation rates in 1995. In 1996 the lending rate was 13.41 which were accelerated to 14.16 in 1999.

Supply shortages in the rural areas originating from political instability in FY96 and disruption due to floods in 1998 caused serious shortfall of food and also hampered all other agricultural production, which ultimately caused higher inflation rates in1996, 1998 & 1999. A lower growth rate, because of lower production and relatively higher depreciation of the exchange rate due to food imports, also contributed to the higher inflation rate in the flood affected years. Larger depreciation of the exchange rate has accelerated the inflation rate 2.79(2002) to 4.38 (2004). Exchange rate might have played a significant role in causing inflation in 2005-2006 because of the introduction of flexible exchange rate regime since May 2003. A higher growth of money supply (13.84 at 2004 to 19.51 at 2006) added a lot to inflation in 2005-2006.

In 2001 the lending rate was 13.75 which were lowered to 10.93 in 2005. In 2001-2006 high inflation in food (more than 5 percent) sector at international market was so much responsible for the fluctuation of inflation. Typically import occupies a significant place in the Bangladesh economy, accounting for as high as above 20 percent or more of GDP in FY06. At the margin, most of the essential food items (for example, sugar, rice, wheat, onion and edible oil) and, more generally, machineries, intermediate goods and raw materials used in production are imported. Cost of imports can, therefore, be expected to have a substantial influence on domestic inflation (during 2001-2006) directly (through final goods) or indirectly (through intermediate goods). Unfair cartel among the suppliers might seriously hamper the course of the economy by engendering inflation via the creation of a false supply shortage even during a period of robust growth in production. Such an undesirable event allegedly occurred in FY06 when the food inflation remained high (7.76 percent) in the same fiscal year despite the growth in food production (4.49 percent8 vis-à-vis 2.21percent in FY05).

Monopolistic control of several food items such as sugar, onion, pulses and edible oil by market syndication seems to have led this situation.9Obviously such manipulation is a type of supply side disturbance. Inflation has emerged as a global phenomenon in recent months largely reflecting the impact of higher food (The IMF food price index was 44.4 percent at June 2008)and fuel prices and strong demand conditions especially in the emerging economies. In line with global trends, Bangladesh also experienced rising inflation with the 12-month average CPI inflation touching 9.94 percent in June 2008. In the fiscal year 2009, global oil price has shifted upward dramatically so fast. So that the price of fuel & power has driven very sharp impact on our economy by increasing the price of Industrial product and reduces the output of industry. Though our government has taken needed initiatives to minimize the inflation rate but they have failed up to the expectation. In the fiscal year 2010, global food price has shifted upward dramatically so fast .So that the price of food has driven very sharp impact on our economy. Though the inflation has decreased to a reasonable rate (5.4 percent), the price of food is beyond to the normal people. Because of the insufficiency of credit to productive sectors it is unable to invest money in productive sectors whereas the money are using in less productive sectors which causes a high rate of inflation.

Limitations of Economic system

The quarterly data on budget deficit and government expenditures are not available, which hinders the analysis on the supply side determinants of inflation. The wage rate is not considered here because of the developing country nature, Labor is assumed to be abundant. The key findings: Inflation in Bangladesh can be explained by money supply growth as money supply has statistically significant power of forecasting the movement in CPI. It might be channeled through either the effects of money supply on GDP or the effects of money supply on exchange rates. The deposit rate of interest is a relatively weak determinant of fluctuations in inflation in Bangladesh, whereas deposit rate of interest is a moderately strong determinant of nominal exchange rate, but only in the short run. Money supply is a moderate determinant of fluctuation in real output, at the same time; money supply is a moderately strong determinant of fluctuation in nominal exchange rate in Bangladesh during the period FY90-FY10.

Conclusion
These results have important policy implications for both domestic policy makers and the development partners. First, taking into consideration that the inflation rate is not indexed in the wages and salaries, inflation will lead to a decrease in the purchasing power and an increase in the cost of living. Second, given that the country frequently has to balance the credit requirements by the private and public sector against both inflationary and balance of payments pressures, it is not always possible for the monetary authority to increase (or adjust) the nominal interest rate above the expected (or actual) inflation rate through contractionary monetary policy 11. In this regard, the monetary authority can think of an alternative way by working on the expectations channel to reduce inflation. This requires credibility of the monetary authority in following through its monetary program as communicated in advance to the stakeholders.

Cite this Economic, Inflation

Economic, Inflation. (2016, Jun 25). Retrieved from https://graduateway.com/economic-inflation/

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