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Causes of inflation

Published: November 23, 2010

Inflation is mainly caused when there is excessive supply of paper money. As the destruction of currency reaches its peak, hyperinflation starts to exact its toll on economy. In Pakistan, fiscal authorities regularly issue large quantities of money to pay for a large stream of government expenditures. Thus money in circulation becomes much greater than is required. It has resulted not only in the rapid decline in value of our rupee but its impact on the daily life of common people is devastating. In fact, inflation is a form of taxation in which the government gains at the expense of those who hold money. Due to devaluation of currency and decrease in its value, the purchasing power of the people of Pakistan has reduced drastically. In fact, inflation is considered to be a sort of a very large taxation scheme. Pakistans consumer price index, the indicator for inflation, has soared to the highest level in its history and has sparked high inflation. There are several other causes that are triggering inflation in Pakistan. Most lethal has been the war on terror. Government of Pakistan is actually printing paper currency faster than the rate at which it is devaluing. Simultaneously, capitalism is also now being blamed for inflation as it is fundamentally based on greed and is immoral. It enables the rich to get richer at the expense of the poor. The free markets are the places where the most ruthless operators unfairly crush their competitors and where the cost of vital products and services, such as food items, health care, education and energy go beyond the reach of those who need them. Capitalism also breeds corruption. Pakistan is a nation blessed with abundant human and natural resources. Despite all this, Pakistani citizens suffer from widespread poverty. The economic output is low in both the private and the public sector due to corruption, wrong policies, inefficiency, and bad governance. An important step forward is to stick to rule of law and transparency and getting freedom from IMFs clutches.

Why dont they eat cake?


By Moniza Inam Monday, 21 Jun, 2010 Each day while coming to work, I pass through a food charity, which provides free meals to the most destitute people of Karachi. The number of individuals who are availing this facility is increasing by the day as more and more peolpe from the lower-middle class are now benefiting from the langar. Due to the mounting food inflation and the absence of social

security nets by the government, masses are ready to avail any help from these philanthropic organisations that are working on self-help basis. The double-digit food inflation has become a major problem for all the segments of populace, however, its influence on the salaried or fixed income groups, lowermiddle class and the 24 per cent of the population that survives on less than two dollars a day, or the official minimum wage of Rs.5,000 per month, is colossal. They are forced to spend up to 70 per cent of their earnings on this account. Although Islamabad was hit by the food crisis in the later half of the 2008, the global economic downturn has severely aggravated the problem. The heartbreaking sight of long endless queues outside the government-run low-price outlets called Utility Stores throughout the country is proof that citizens are looking for an economic relief in these challenging times. Explaining his predicament, Mohammad Niaz, a labourer living in Orangi, states that he has an average income of Rs.9,000 per month from which he has to support his family of six persons. After paying the utility bills, house rent and the school fees of his three children, his food budget becomes limited. This is not the story of one man millions of Pakistanis are sailing in the same boat and putting two square meals on the table is becoming a Herculean task. In order to make ends meet and provide three staple meals they have to compromise on the quality of food. Milk, fruits, eggs, meat, and fish are vanishing from their diet; people are eating more vegetables and pulses thus compromising on their nutritional needs. As one friend reminisces nostalgically about a time when one could buy a cheap wholesome lunch or dinner in Rs.5. This is no longer the case as the prices have increased manifold. Now one chapatti costs Rs.6. In this whole scenario, the response of the government has been appalling. They keep passing the buck onto the previous governments and refuse to claim any responsibility. They also blame international factors that are beyond their control, such as current global recession and the pressure from international agencies. In fact, their response is reminiscent of Marie Antoinettes infamous advice to her starving population, let them eat cake, she callously stated. This is very astonishing as the area comprising Pakistan is very fertile and in the British era was known as the granary of the country and was exporting food to the other parts of the Empire. There are host of factors that have contributed in this state of affairs. The environmental degradation and haphazard urbanisation tops the list. As one elderly family member recalls his journey from Lahore to Sialkot, he states wilfully that once you crossed the Ravi Bridge there was foliage all around you up to the destination, which is 70 miles away.This belt was the most productive region and had been famous for its rice production. Nowadays, when you cross the river you find nothing but factories discharging their effluents into waterways, polluting drinking water and endangering agriculture, along with low income housing schemes, shopping plazas, ***** heaps and marriage halls. Mind you, he is talking about the most fertile arable land in the world, which has been lost due to our ill planning and lack of foresight.

According to the Pakistan Institute of Development Economics report, nearly 300 million acres of arable land (which is by no means a minute figure) has been capitulated by the lopsided urbanisation in the form of townships, railway stations and factories. The other very important factor is related to climate change and global warming which brings recurring droughts and floods in the country. Coupled with poor water management, outdated farming practices and decreasing water level in Punjab and desertification in coastal districts of Sindh due to the construction of upstream dams, has affected our food production in a major way. And this vicious cycle is complete when the population is multiplying at an alarming rate of 2.8 per cent annually. No wonder, the number of food insecure persons is increasing on a daily basis as well. This food insecurity brings many social, political, cultural and militancy related issues in focus. Its an established fact that hungry men are angry men and they are always ready to vent out their frustration on the state or those institutions of governance which they think are responsible for their predicament. This recognised fact can be corroborated by the increasing rate of petty crimes, poor law and order, kidnapping for ransom, and militancy and terrorism at large, which are threatening the very foundation of the state. It is time that the government re-examine its priorities and after years of neglect and apathy make attempts to rejuvenate the agriculture sector as well as, make a conscious effort to provide food security to all citizens. This country needs a basic change in paradigm that views individual hunger as a national security threat.

Is economic policy forever doomed to be hostage to visceral sentiments? Listening to the rage surrounding the reformed general sales tax (RGST) legislation you would think the government is trying to introduce cannibalism. Its easy to forget that every government since 1990 has tried to implement the reforms contained in the RGST legislation, and faced the same opposition from the same quarters. Politics aside, its worth considering some of the arguments presented against the bill. Topping the list is the one asserting that the bill will fuel inflation. This is a tricky one to explain, or even reliably pronounce on. For one, a large chunk of the exemptions that are being withdrawn are those that deal with agriculture inputs. Since agri products are the mainstay of our food supply, and the main raw material for our largest manufacturing sector, there is clear concern that the imposition of this tax will be passed down the supply chain to end users. The chief concern here is with the urban consumer, who is already weighed down with a sharp increase in food prices. The voiceless urban consumer, who has any number of parties purportedly speaking on his or her behalf. How does one explain to this voiceless, faceless urban consumer what the root causes of inflation in this country really are? Parties vested in tax exemptions and cheap money, our speculator and rentier elites who claim to be industrialists, are trying to stoke the fears of the urban consumer by

saying the new tax and high interest rates are to blame for the price hike and high unemployment. This is as disingenuous an argument as they get. The root causes of inflation in Pakistan have not been studied at all and it is not possible to pinpoint cost-push factors or fiscal overruns as the main cause. The central bank insists the monetisation of the deficit is what is fuelling inflation, while industry insists that inflation is cost-push meaning raising interest rates is not going to help stem it in any meaningful way. No independent voice has yet pronounced on the matter, no weighty verdict exists on this crucial debate in economic management that has raged at least since 2004, when inflation reared its ugly head. This ambiguity on a key question in our economic life is today is fuelling a lot of the firestorm of controversy that the RGST has ignited. Granted its difficult to get the urban consumer interested in debates over the root causes of inflation. The urban consumer only wants that he or she should pay less next time they go to the grocery store, not clarity on whether fiscal or cost-push factors are driving the inflation that is eating away his or her standard of living. But a consensus of the elders is still necessary to get certain policy measures onto the governments radar without igniting undue controversy, and it is the absence of such a consensus that is the root of the sound and fury surrounding the RGST legislation today. To understand what this consensus of the elders is, think of what they once called the Washington Consensus the term accidentally popularised by John Williams. A set of policy measures had behind it the support of all the major economic institutions of the world, from the Federal Reserve Bank of the US, to the IMF, to the ECB and the World Bank. With such a powerful consensus backing it up, the same set of policy proposals found their way into all prescriptive programs for the economic difficulties faced by developing countries. The consensus itself was open to debate, and sure enough was hotly contested. But so long as it remained, it provided certain stability to thinking on economic policy matters. Today Pakistan needs stability in economic thinking. The Washington Consensus may have come and gone, but no consensus has replaced it yet. The question of the root causes of inflation is central to forming a new consensus on our economic policy. On that question rests our future direction over fiscal and monetary policies. Let this be one call to all our economic managers to do the needful to forge such a consensus. May we please know what exactly are the root causes of inflation in this country?
Inflation in Pakistan

Too much money chasing too few goods. The last five years saw high inflation due to expansionary monetary policy and high oil prices. The sustained level of high economic growth over the years has increased the level of income, which has resulted in a surge in domestic demand. High international oil prices lead to increase in transportation charges as well as energy intensive industry products such as metal commodities. As producers pass on the increased costs to consumers, this leads to an increase in cost of Pakistani imports, which drives up inflation. Domestic production should be encouraged instead of imports; investment should be given preference in consumer goods instead of luxuries. Agriculture sector should be given subsidies, foreign investment should be attracted, and developed countries should be requested for financial and managerial assistance. And lastly a strong monitoring system should be established.

Relationship of fiscal policy with inflation There exists a strong relationship of fiscal policy with inflation. Different studies have shown that factors such as demand relative to supply, private sector credit, exchange rate, tax revenue, direct and indirect taxes and wheat support price have a great impact on inflation. In Pakistan, over the last few years inflation has been caused by excessive fiscal deficit. Imports went up largely due to rising demand while production of local goods remained unsatisfactory. Rising oil and food prices in the international market have been, no doubt, the largest contributions to inflation. Indirect taxes by the government in the form of sales tax have pushed the prices of commodities upwards. Emphasis on direct taxes was not given in order to control the inflation.
Saturday, August 22, 2009

Inflation and its Causes


INFLATION In ordinary sense inflation mean a general rise in prices. A rise in prices is the indication of inflation. Basically inflation represents a situation whereby the aggregate demand for goods and services exceeds the available supply of output. In the Keynesian sense, true inflation begins when the elasticity of supply of output in response to increase in money supply has fallen to zero or when output is un-responsible to changes in money supply. When there exists a state of full employment the conditions will be clearly inflationary, if there is increase in the supply of money. But since we do not subscribe to the classical view that there is full employment we can say that when money supply increase it results partly in the increase of output (GNP) and it partly feeds the rise in prices. And when the supply of output lags for behind, the rise in prices is described as inflationary. In Coulborns words, it is a case of too much money chasing too few goods thus inflation is generally associated with an abnormal increase in the quantity of money resulting in abnormal rise in prices. CAUSES OF INFLATION There are so many causes of inflation in the less developed countries like Pakistan. Inflation may occur due to any one of the following reasons or causes. 1. Increase in Demand: Due to increase in population or due to change in certain other factors, the demand for goods and services measures supply remaining the same, expenditure will increase and inflation occur.

2. Lack of Supply: Due to some unfavourable climatic situations, political, social, national or international situation production remains low (small) in any particular year and supply will also decrease, prices will go up and inflation will occur. 3. Increase in the Cost of Production: In certain cases cost of production increases due to rise in the prices of factors of production, producer rises price level and due to excessive expenditure inflation occur. 4. Over Population: Inflation also occurs due to the increasing rate of growth of population. As Pakistan is an over populated country and the rate of growth of her population is about 3% per year, while the rate of production of goods is very low and due to this prices of commodities rise and inflation occur. 5. Development Expenditure: In under developed countries like Pakistan major amount of money is spent on the development programmes and due to increase in the income of the individuals, their expenditure is the basic cause of the inflation. 6. Food Problem: Pakistan is basically an agricultural country. Near about 30% of national income is had by agriculture sector. But unfortunately there is an acute shortage of food grain in Pakistan and so is the case with other developing and under developed countries of the world. The prices of other commodities are influenced by the continuous rise food grain prices and thus inflation occurs. 7. Financial Position of Common Man: In under developed countries, the financial position of a common man is very poor and there is a lock of saving because the major portion of income is spent on the purchase of only consumer goods. 8. Import of Machinery: Under developed countries spent lot of amount on the import of machinery. So the cost of production increase and inflation occur this price of goods also increase and inflation occur. 9. Expenditure on Defence: Of course defence is very important for every country. A huge amount of budget is spent on defence requirements in all countries of the world. Like other countries Pakistans major part of budget is spent on defence requirements. As we only produce 5% of total defence requirements within country and the remaining requirements are imported from abroad. Due to this reason inflation occurs. 10. Natural Climate: Natural climate play an important role in the economy of any country. Pakistan is basically an agricultural country we earn near about 30% of national from agriculture sector. Agricultural products wholly depend upon natural climate. Due to unfavourable natural climatic conditions when agricultural cross are destroyed or decreased as a result of this supply decrease and prices increase and inflation occur. 11. Deficit Financing: By deficit financing we mean that there is deficit created in budget when budget is announced. Expenditure is more than income in actual sense by deficit financing mean to issue new currency when this new currency came into the market it increases the demand of goods and services but on the other hand supply remain the same as a result of this price increase and inflation occur. 12. Decrease in Production: Inflation may occur if production decreases. There are many reasons of decrease of production e.g. natural climate, political, social conditions, competition, national and international problems etc which are cause of inflation. MEASURES TO CONTROL INFLATION The methods which are adopted to remove inflation, they are called anti-inflation measures. These measure may be of the following three kinds. 1. Monetary Measures 2. Fiscal Measures 3. Non-Monetary Measures or General Measures. Let us discuss these turn be turn 1. MONETARY MEASURES Monetary measures mean those measures which are taken by the Central Bank of the country. Antiinflationary measures of pure monetary nature are largely a matter of Central Bank policy. These are discussed as under. (i) Bank Rate Policy: In the time of need the people may discount the bills from commercial banks. When

there is inflation in the country then banks should increase the rate so that people can not get cash by discounting the bills. This is the bank rate policy and is major weapon of controlling the inflation. (ii) Open Market Operation: When Central Bank sales or purchases the securities in open market, it is called open market operation. If there is inflation in the country then central Bank should sell the securities so that the inflation may be controlled. (iii) Higher Reserve Requirements: Higher reserve requirements are also necessary to control the inflation. Because of reserves are increased then purchasing power of people is also decreased. (iv) Monetary Reforms: The Government can order to exchange old notes by new ones in this way a large part of money may be blocked. Money should be repaid to people after achieving the purpose. (v) Marginal Requriement: Marginal requirements means the value of securities against which banks agree to advance loans. If banks increase the marginal requirement then people can not get more loans and inflation may be controlled. (vi) Credit Rationing: Sometimes Central Bank advises to commercial banks to stop the advancing loans for one month or two months or more. In this way inflation may also be controlled. 2. FISCAL MEASURES (i) Cut on Expenditure: If government decreases her expenditure on unproductive activities then inflation is also automatically controlled. (ii) Change in Taxation System: Tax system should be reorganised to encourage investment and productive activities in the country. It may help to increase production and to control the general price level. (iii) Restriction on Exports: Government may control inflation by applying restriction on the export of those goods which other wise may create shortage in the country. (iv) Managing Public Debt: Public debt should be managed in such a systematic way that money supply is reduced and consequently the inflation may be removed. (v) De-nationalization: To control the inflation government should de-nationalize sick public industries. The experience of nationalization of industries in Pakistan has been quite bitter for economy. (vi) Protection to Infant Industries: To control inflation, increase in domestic production is required. So government should protect the domestic infant industries by applying import duties. 3. GENERAL MEASURES (i) Population Planning: The demand of goods and services may be controlled by control of population growth. So effective population planning may also help to control inflation. (ii) Co-operation between Monetary and Fiscal Policies: Government may control inflation, if there is a proper co-operation between fiscal and monetary policies. (iii) Effective Planning: Administration and politician may help to control inflation by making policies for the interest of the whole nation and by sacrificing their personal benefits. (iv) Increase in Output: Steps should be taken to increase the output, so that the shortage problem of goods can be removed. If there are sufficient products in the market in sufficient quantity. Then the too much money will not chase too few goods and in this way the inflation will automatically be controlled. (v) Political Stability: Government should take the steps to remove the political crisis so that business sectors are encouraged to invest in the country. This is very positive and natural way of controlling inflation. (vi) Discipline: There should be discipline in factories and offices so that output of the country may increase and inflation is controlled. (vii) Hoarding and Smuggling: Hoarding and Smuggling should be controlled because if hoarding and smuggling are controlled then inflation is also controlled.