INFLATION: BOON OR BANE?
PROF. SAEED AHMAD SIDDIQUI
Oct 24 - 30, 2011
The economy of Pakistan occupies 47th position in nominal terms and 27th position on the basis of PPP (purchasing power parity) in the world.
Pakistan is a semi-industrialized country having textiles, chemicals, food processing, and other agro-based industrial units.
Its economy has been facing internal political disputes since many decades. Moreover, the country has also been suffering from ever-growing conflicts with neighboring India.
Amongst all, inflation is the gravest and serious problem. In 2008, as a result of record increase in global oil prices, the inflation reached to the extent of 25.33 percent.
Inflation refers to the situation when the purchasing power of a nation decreases due to increase in prices. It should be noted that inflation is a natural phenomenon. Increase in population increases the demand for goods and services. Appreciation in prices is a must during the time between increase in demand and due response by supply.
In other words, inflation is the normal economic development provided annual percentage of rise in prices remains adequate.
If the price rise exceeds beyond certain level, it will turn inflation into a crisis. If supply of money increases excessively, it is termed as monetary inflation. Since the supply of money relates to the prices, it is called price inflation.
Inflation also refers to the fall in the real value (purchasing power) of money. When average prices increase, the one unit of money (rupee) does not remain able to purchase the same amount of goods that it can purchase previously. The inflation is measured through change in general price index also called consumer price index (CPI).
The economists agree that generally, the excessive increase in money supply causes hyperinflation and that is why central bank is assigned the responsibility of controlling the money supply and arresting the rate of inflation at lowest possible point. Central banks, keeping this objective in view, adopt various measures like raising bank rate, increasing cash reserve ratio and statutory liquidity requirement for the commercial banks, open market operation etc.
CAUSES OF INFLATION
There may be various reasons of inflation. For instance, when money supply is increased without simultaneous increase in goods supply. Increase in money supply more than the real GDP, pushes up inflationary pressures. Since inflation, in this situation, is a result of price hike, it is termed as demand-pull inflation. Another cause of inflation is increase in the cost of producing goods. If the production cost is appreciated, the producers increase the price of products to maintain profits, which create inflation in an effect.
Similarly, if laborers demand high wages and producers are compelled to increase wages then they transfer financial burden to the consumers by factoring in high labor cost in the final cost. The inflations created due to increase in product cost and wages are called cost-push inflation, and wage induced inflation, respectively. Payment of heavy debt servicing (interest on foreign loans) also speeds up the pace of inflation. Inflation is also created, if rate of exchange becomes adverse for the local economy due to appreciation in the prices of imported goods and raw materials.
Inflation is also a result of heavy government taxes. Inflation may be the result of abnormal rise in the price of stocks and real estate called estate price inflation.
Fall in direct and indirect taxes may lead to inflation due to increase in disposable income of people, which increases inflationary pressure.
Inflation is a global phenomenon but some specific reasons have added fuel to the fire in this part of the world. We can categorize the main causes of inflation in Pakistan as hereunder
1. Fast growing demand creates a demand- supply gap, which increases pressure on general prices.
2. Supply side shock makes the prices of food items and oil volatile and since this shock prolonged, demand management and even monetary policies could not be successful in bringing the economy out of inflationary trap.
3. Strategy of filling the demand- supply gap through imports backfire as trade deficit continues to escalate.
4. Fiscal policies, during the past years, have been highly expansionary, which increased the local demand enormously and pressure was built on current account deficit. Combating the fiscal deficit, new currency is printed which increases saving-investment gap. Foreign assistance becomes a must to fill this gap. Besides, heavy loans are acquired from the central bank for the purpose.
5. Expectation effect, in boosting the pace of inflation, plays very important role. The loans acquired for production purpose are channelized towards purchase of real estate and stock markets.
6. One of the causes of high inflation in Pakistan has also been expansionary monetary policy. Rapid supply of money and easy credit policy increases inflationary trend. Growing credit is necessary for economic developments. Nonproductive uses cause inflation.
7. Rising import prices exacerbate inflationary pressures.
AFFECTS OF INFLATION
Fall in the value of money affects especially the pension holders because their fixed income (real) decreases. But, the people who don't have fixed income can compensate fall in their purchasing power. Inflation changes the pattern of income distribution in the society. In other words, the income flow changes its course from rich to poor rather poor to rich class creating a wider gulf between the two classes. The most important function of money (storing the value of goods and services) weakens due to inflation because money, with the passage of time, can store lesser amount of goods and services due to appreciation in general price level.
CAN INFLATION BE A BOON?
Yes, it can. Economists agree that inflation within a reasonable limit (4-6 per cent) is needed for development because inflation increases prices, profits, employment, wages, production, savings, investments, and overall pace of economic growth and development. But, when inflation exceeds this reasonable limit (as happening in Pakistan), it becomes highly injurious economically, politically and socially. As a result of hyper inflation, value of money falls and the expected profits and losses of lenders and borrowers become uncertain. Uncertainty affects savings and investments. More than half of the income of poor class is spent on food items.
The past, affecting the present, pushes the inflation to its height and both rich and poor people are worried. The government has adopted various measures to deal with the situation. The government, to increase the supply of goods, has adopted relaxed import policy. The state bank of Pakistan kept monetary policy tight for a quite long time. Moreover, the government encourages imports of sugar and pulses. Utility Stores Corporation of Pakistan (USC) has expanded its coverage so that the people may have the necessities of life on low and reasonable prices. This corporation provides wheat flour, cooking oil, ghee and pulses at lower than the market prices.