Inflation and It's Effect on Pakistan Economy Essay

Inflation is the rise in the prices of goods and services in an economy over a period of time - Inflation and It's Effect on Pakistan Economy Essay introduction. When the general price level rises, each unit of the functional currency buys fewer goods and services; inflation is a decline in the real value of money and the loss of purchasing power of people. Inflation is a key indicator of a country and provides important view on the state of the economy and the policies of the government. Reasons of Inflation: It has been generally agreed by the economists that high rates of inflation and hyperinflation are caused by an excessive growth in the supply of money.

Today, most economists favor a low steady rate of inflation. 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. There are many causes for inflation, depending on a number of factors. For example, inflation can happen when governments print an excess of money to deal with a crisis.

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When any extra money is created, it will increase some societal group’s buying power. All sectors in the economy try to buy more than the economy can produce. To compensate, some merchants raise their prices. Others don’t offer discounts or sales. In the end, the price level rises. This is called demand-pull inflation, in which prices are forced upwards because of a high demand, and excessive monetary growth. For inflation to continue, the money supply must grow faster than the real GDP. Another common reason 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, this in turn leads to the company increasing prices to maintain their profits, this kind of inflation is call cost-push inflation. Furthermore, rising labor costs can also lead to inflation, because workers demand wage increases, and companies usually chose to pass on those costs to their customers, this sort of inflation is called cost-push inflation. 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. Finally, inflation can also be caused by federal taxes put on consumer products. 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.

Effects and measurement of inflation: * The most immediate effects of inflation are the decreased purchasing power of the rupee and its depreciation. Depreciation is especially hard on retired people with fixed incomes, as spending power decreases each month. Those not on fixed incomes are more able to cope, because they can simply increase their income. Inflation alters the distribution of income. Lenders are generally hurt more than borrowers during long inflationary periods, which mean that loans made earlier are repaid later in inflated rupees.

Inflation weakens the function of money as storage of value, because each unit of money is worth less with the passing of time. The progressive loss of the value of money during a period of inflation makes the borrowers to be less willing to use the money as standard differed payments. * Distortion of relative prices, usually the prices of goods go higher, especially the prices of commodities. * 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 they’re losing money if they don’t take into consideration the inflation rate when calculating profits). * Causes an increase in tax bracket (people will be taxed a higher percentage of their income increases following an inflation increase). Causes business cycles (many companies will have to go out of business because of the losses they incurred from inflation and its effects). * Currency debasement (which lowers the value of a currency, and sometimes cause a new currency to be born) * Rising prices of imports (if the currency is debased, then its purchasing power in the international market is lower). To measure the price level, economists select a variety of goods and construct a price index such as the consumer price index (CPI). This is one measure of inflation.

The CPI measures inflation as experienced by consumers in their day-to-day living expenses; it is the ratio of the value of a basket of goods in the current year to the value of that same basket of goods in an earlier year. By using the CPI, the inflation rate can be calculated. This is done by dividing the CPI by the beginning price level and then multiplying the result by 100. The GDP deflator is another very important measure of inflation as it measures the price changes in goods that are produced domestically. In Pakistan, the main focus to calculate rate of inflation is on the CPI as it is more representative of 380 basic items.

The government is cautious about inflation and thus has taken various steps to release demand pressures on the one hand and enhance supplies of essential commodities on the other. To ease demand pressures, the State Bank of Pakistan (SBP) has continuously tightened the monetary policy over the last three years and more so in the current fiscal year, while to enhance supplies, the government has relaxed its import regime and allowed imports of several essential items so that there is a continuous flow in the supply of those important commodities.

In addition, the government increased the imports of items like wheat, pulse and sugar to complement the efforts of the private sector. In order to provide relief to the common man, the government also increased the scale of operations of the Utility Stores Corporation (USC) which supplies essential commodities such as wheat flour, sugar, pulses and cooking oil/ ghee at less than the market prices. Impact on Business sector: Due to high inflation rate central bank, State Bank of Pakistan has to raise its bench mark to 14% means tight monetary policy since last 2 years.

This would result in high interest rates and high cost of doing business which is already very high in region and disappointing the investors. This monetary policy hurts investors and caused in declining of FDI for consecutive four years. This causes the low growth and no job opportunities in the country. Similarly due to power failure, terrorism, high fuel and other commodity prices in international market caused the failure in export orders and really hit hard to our business sector. Pakistan’s current inflation rate according to CPI index is 12. 69%.

Sources:

Jang News CNBC Pakistan
www. finance. gov. pk
Wikipedia Opfblog. com

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