Rate Of Inflation In Pakistan Economics Essay

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Rates of inflation on yearly basis in Pakistan (1990-91 = 100)

1Inflation Rates based on Consumer Price Index (CPI)




































2In our country (Pakistan) there was an increase in economic growth which was over 6% during 2004-06. But on the other hand there in an increase in the prices very fast and increase in the inflation rate is above 8% for last two years. The CPI (Consumer Price Index) shows the 9.3% during the period 2004-2005 and 8% in 2005-06.

Four different price indices are published in Pakistan: the consumer price index (CPI); calculated for four different income groups; the whole sale price index (WPI); the sensitive price index (SPI); and the Gross Domestic Product (GDP) deflator. In Pakistan, the main focus is also placed on CPI because it is used for indexation for many wages and is more relevant in measuring inflation as its impacts on households. Major developments have taken place during the recent past years as far as measurement of inflation is concerned. Not only the base year for CPI and SPI has changed from 1990-91 to 2000-01 and their coverage in terms of cities, markets, and items; weights for different commodities; income and occupational groups have also changed. They are not only more representative but include items, which are widely consumed by different income groups.

Inflation rates from 1991 to 1995 have ranged between 9.25 and 12.9 percent. The high rates of monetary expansion, low rate of economic growth in three out of the five years and adjustment in administered prices contributed to the relatively high rates of inflation. Substantial depreciation of the exchange rate in 1990 and in 1994 also resulted in a relatively sharp increase in the price of tradable (in rupee terms) in these two years. The rate of economic growth, which had flattered in 1989 and 1990, recovered strongly in the next two years. The recovery was short lived as growth rate plummeted in 1993 to its lowest level in over two decades. The growth rate improved in the next two years but is still below its historical average. High budget deficits during these years contributed to the monetary expansion. In 1994 the rate of monetary growth was 16 percent, although budget deficit was brought down to 5.8 percent of the GDP. The persistence of a double-digit inflation along with large fiscal deficit (7.0% of GDP) has been the major source of macroeconomic imbalances in the 1990s. There has been a general agreement that the excessive growth in money supply, the supply side bottlenecks, the adjustment in government - administered prices, the imported inflation (pass through of exchange rate adjustment), escalations in indirect taxes, and inflationary expectations has the major factors responsible for the persistence of a double-digit inflation during most periods of the 1990s. There is a sharp increase in food items that in 13.4 % in 2004 whereas in the previous year it was less 0.9%, taking annualized food inflation to 6.0 percent for the financial year 04.

Task 2

2.1 Define inflation.

The national price level rises for the same reason that prices of particular goods and Services rise-namely, that there is more demanded than supplied at a given price. When people have more money, they tend to spend more. Without a corresponding increase in the volume of output, the prices of existing output simply rises because the quantity demanded exceeds the quantity supplied at current prices and people bid against each other when there is a shortage. For inflation we can say that it denote a general increase in the prices of all goods and services in an economy.

2.2 Two causes of inflation

There are two causes of inflation

Inflation due to increase in demand called demand pull inflation

Inflation due to increase in the cost of production called cost push inflation

2.3) the inflation crisis and how to resolve it

3Equilibrium economics says that a contraction in the money supply eventually should self-correct-prices and wages should drop to reflect less money in circulation, and eventually everything should get back to normal full-employment equilibrium. In the Great Depression, prices and wages did indeed drop, but this deflation caused people to spend even less further exacerbating the downward spiral. Keynes argued that these dynamics could cause economies to get stuck out of equilibrium for very long periods. So to knock the economy back to full employment, Keynes advocated that the government play a role by injecting money into the system. This injection of money causes spending to stop dropping, unemployment to stop rising, and confidence to return, reversing the vicious downward cycle into a virtuous upward cycle. But it was argued that the kind of government spending Keynes advocated would not lead to long-term growth, but only to higher inflation.

Mr. Montesquieu as France's greatest economist, primarily due to his embryonic liquidity-preference theory of interest, his opposition to hoarding, and his advocacy of a high level of money expenditure to maintain and promote economic welfare. Yet, unlike Keynes, Montesquieu was a passionate supporter of the doctrine of laissez-faire. He detested authoritarian regimes and rejected all forms of central planning, which, he said, robbed society of its natural dynamics. He defended free trade as a civilizing, educating, and cooperative force between nations. Montesquieu taught that industry and commerce were equally significant as fountains of prosperity. Entrepreneurship and frugality were essential ingredients to economic growth. While Keynes preached that capitalism is inherently unstable and has no natural tendency toward full employment. Yet, at the same time, he rejected the need to nationalize the economy, impose price-wage controls, and interfere with the micro foundations of supply and demand. All that was needed was for government to take control of a wayward capitalist steering wheel and get the car back on the road to prosperity.

2.4) Monetary policy

4One way to reduce or control inflation is to use monetary policy. The Central Bank issue lending rate of federal funds at a low level, the target rate is 2% to 3% p.a. and objective is to low level of inflation from about 2% to 6% p.a.

2.5) Fixed exchange rates

This system operate through tied the value of own currency to another single country currency or through other countries currencies. This method is used usually to maintain the value of own currency.

Other methods for reducing inflation are as under:

Gold standard

Wage and price controls

Cost-of-living allowance

Task 3

(A) [5] The most common reason for a change in the absolute price level is inflation occurs when the average level of prices in the economy increases over time. Even as overall prices are increasing, particular relative prices will change. Prices of some commodities will increase more slowly than average (thus becoming less expensive in relative terms), while others increase more rapidly (becoming relatively more expensive). For a few commodities (like electronics), prices might decline in absolute terms despite the rise in the overall price level. These products thus become doubly inexpensive in relative terms - since their absolute prices are falling while most other prices are rising. The real price of any commodity is its price adjusted to reflect any change in the overall price level. A commodity's real price is therefore its particular relative price compared to the general level of all prices. A commodity's real price goes up if its absolute price (measured in dollars) rises faster than the overall price level. A constant increase in the inflation will decrease the purchasing power of a person. We can elaborate through an example that one person having 100$ under his bed and increase in the rate of inflation is 10% then it is not possible for a person to buy 100$ worth of a goods for 100$. In other way that person lost his purchasing power by 10% and buy goods less than in 100$.

(b) Interest rates, is measured in real terms, as the difference between the nominal interest rate (in percent) and the rate of inflation. If a bank charges 5 percent annual interest for a loan when overall prices are also growing at 5 percent, the bank's wealth doesn't change - because the loaned money, once repaid with interest, has no more purchasing power than it did when it was loaned out. If interest rates are lower than inflation, then the real interest rate is negative: the borrower, not the lender, is better off at the end of the loan because the money they pay back is worth less than the money they borrowed. The higher is inflation, therefore, the lower is the real interest rate. That's why financial institutions hate inflation more than any other sector of society.

In this case, ultimately the amount of loan will increase at the cost of inflation and interest and such sum increase and accumulate the sum of loan payable.

(C) In this case the amount of loan receivable will be increased.

Task 4

4.1 Provide reasons why the government may want to tackle inflation.

Government wants to improvement in productivity and hence reduction in the unemployment in the country and result is an end of recession. The aim of Government is to provide stabilizing prices of the products and services in a country. When Government increase investment for the purpose of increase and improvement in the productivity of the goods and services and money circulation prevailing in a country where people get employment and business cycle will increase and end of the recession. When new investment occurred in the shape of new plants and machinery and increase in the transportation facilities in the country and simultaneously required people to operate these plants and machinery and result figure is reduction in employment. So enlargement in investment Government achieves the purpose of feed the hungry people and give people houses and make the country a good place of living. By overcome inflation several other crises will be ended at the same time.

Demand pull inflation

6In this first classification there is a reason for such type of inflation in the country when too much amount of money is required to buy very few goods. The surplus of money causes demand to go above supply of products and services and resultantly increase in prices.

One remedy of this type of inflation is controlled by monetary and fiscal policy. For example the Federal Reserve limited the supply of money and government can reduce its spending thus money in flow will decrease and inflation controlled.

Cost push inflation

7In cost push inflation, there is an increase in the cost of production process and result is increase in the cost of goods and services. For example if there is increase in the cost of input e.g. cost of raw materials or on other side there is an increase in the wage rate of workers and this increase in more than the increase in the productivity then result will be increase in the prices. In this type of inflation the respond rate is not so good and counted as poor. From the classical point of view is concern there is monetary and fiscal restraints. Both such system actually makes worsen cost push inflation because these two measures decrease productivity and increase the cost per unit. However on the other side the modern economists are in disagreement that what is the exact nature of and cause of world wide crisis of inflation. This is certain to say that demand pull inflation is not responsible for such inflation. We all know that productivity increase means the attack on the root cause of this inflation that is cost push inflation. The increase in productivity in the economy especially on three sectors (1) Manufacturing (2) transportation (3) construction Industry. The best performance of these three sectors offset the increase cost of input that is raw materials cost of energy and would decrease pollution with out increase in the mechanism of prices. The only solution for this type of inflation is to produce more outputs for less use of input.

Task 5

5.1 supply-side economics.

This term is used in two dissimilar but correlated ways, one view is that this term denotes that production (supply) inspire the consumption and living normal. In the long term, the income of a person mirror his abilities to produce goods and services that the society values. The increase level of income and living standard can not be achieved with out realize the increase in output. Most modern economists believe on this theory and are called supply-siders. These economists also suggest that how the modification in marginal tax rates increase economic activity. Because it is strongly believed that increase in the marginal tax rates depress income, final output and the efficiency of resource used. The marginal tax rate is critical and main theme because this is the marginal tax rate which tells the position of ones income that how much is income will go to tax authorities and which one he is able to retain. For example when the rate of tax is 40% then it means that you have to pay 40$ to tax department and remaining 60$ retainable out of 100$ on additional earning. Resultantly the people will keep less money on additional earnings.

From the point of view of classical economics, this supply side economics suggests that one or two factors are countable to the prosperity of a country. 1) Production or 2) supply and secondary consequences are 1) consumption or 2) demand. According to this policy that original goods produced have certain values to other goods and with the help of one willingness this value of goods is traded to other goods.

8The fiscal policy has stressed that how changes in government purchases and changes in taxes influence the quantity of goods and services demanded. Most economists believe that the short-run macroeconomic effects of fiscal policy work primarily through aggregate demand. Yet fiscal policy can potentially also influence the quantity of goods and services supplied. For instance, consider the effects of tax changes on aggregate supply. One of the Ten Principles of Economics in is that people respond to incentives. When government policymakers cut tax rates, workers get to keep more of each dollar they earn, so they have a greater incentive to work and produce goods and services. If they respond to this incentive, the quantity of goods and services supplied will be greater at each price level, and the aggregate-supply curve will shift to the right. Some economists, called supply-siders, have argued that the influence of tax cuts on aggregate supply is very large. Indeed some supply-siders claim the influence is so large that a cut in tax rates will actually increase tax revenue by increasing worker effort. Most economists, however, believe that the supply-side effects of tax cuts are much smaller. Like changes in taxes, changes in government purchases can also potentially affect aggregate supply.

Suppose, for instance, that the government increases expenditure on a form of government-provided capital, such as roads. Roads are used by private businesses to make deliveries to their customers; an increase in the quantity of roads increases these businesses' productivity. Hence, when the government spends more on roads, it increases the quantity of goods and services supplied at any given price level and, thus, shifts the aggregate-supply curve to the right. This effect on aggregate supply is probably more important in the long run than in the short run, however, because it would take some time for the government to build the new roads and put them into use.

5.2) Specific Countries where cost push inflation is used

United States of America and Pakistan use this policy. [9] Success requires economic growth, and that can only be achieved by keeping taxes low. Tax rates range from the edenic zero to the punitive 80%. With the proceeds of these taxes the country can build costly military or police forces and the infrastructure to support economic and technological advancement. Why not simply keep taxes high and meet all the "societal needs" a despot could want? Because keeping taxes high leads the population to produce less. As tax rates increase there is, at first, no easily discernable effect on the populace, except perhaps a few frowns and grumbles. But as soon as taxes reach a certain point-10% in some games, 20% in others-citizens begin to revolt. . . . In games covering a single city, citizens vote with their feet and begin leaving town. No new jobs are created, and once-vibrant down town areas are left with little traffic but plenty of crime. Tax rates that approach 50% or more accelerate the trend. . . . During times of great military conflict or bursts of government construction, tax rates can be increased for a number of years without too much damage to the populace, and revenues do increase from the previous year. The government can simply buy what it needs from increased revenue. But a long war or government building program creates problems in "growing the economy" if tax rates are too high. Production slumps. The busy empire builder finds that his starships are harder to produce. Before long a once mighty empire is tottering on the brink of collapse and the ruler is deposed. The wise ruler keeps taxes as low as possible consistent with enough guns and roads to keep the country safe from a takeover by the enemy.