i INFLATION:

Inflation is the persistent increase in the general price level of goods and services in an
economy in a given period of time.
Inflation is accompanied by the fall in the value of money i.e. the purchasing power of the
currency reduces.
Inflation is measured by using price indices. ( already covered in National income).

OTHER CONCEPTS RELATED TO INFLATION:

DEFLATION. This refers to persistent decline/fall in the general price level of goods and
services in the economy due to fall in aggregate demand in an economy.
Measures of controlling/checking a deflationary gap:
 Use of expansionary monetary policy
 Increase government expenditure
 Reduce direct taxes/reduce taxes on incomes
 Provide subsidies to consumers
 Increase wages of workers.
 Encourage exports

REFLATION: This refers to a deliberate government policy which is undertaken to force

prices upwards in order to help an economy to recover from an economic depression.

Instruments of a reflationary policy in an economy include the following:

 Reduce direct taxes/ reduce taxes on incomes.
 Increase in government expenditure through subsidisation
 Encourage exports
 Use of expansionary monetary policy e.g. through lowering the bank rate, buying back
government securities.
 Increase the level of wages of the workers.
 Subsidise consumers

DIS-INFLATION: This refers to policies undertaken by the government to control inflation

rates in the country.
SUPPRESED INFLATION: This is a situation where demand exceeds supply but the effect of
this on prices is minimised by use of price controls and rationing of goods.

DEMERITS OF SUPPRESED INFLATION:

 It leads to high administrative costs due to carrying out rationing of commodities and
implementing price controls.
 It breeds black marketing due to shortage of commodities.
 It discourages investment due to price controls.
 It leads to diversion of resources from the production of essential goods whose prices are
set/fixed by the government to those goods whose prices are not controlled.
 HEADLINE INFLATION: This measures changes in the price levels of all goods in a given
country/ region over time.

UNDERLYING INFLATION: This measures changes in the price levels of goods excluding
the value of foodstuffs in a given country over a given period of time.

TYPES OF INFLATION ACCORDING TO THE DEGREE OF CHANGE IN PRICES/

STATE OF INFLATION:

NB: State of inflation is the speed at which the general price level is changing.
OR: State of inflation is the rate/speed/ degree of intensity at which prices increase in an
economy over time.
The state of inflation is categorized into two;

1. Mild /Creeping/Gradual inflation:

Mild inflation is one whereby the persistent increase in the general price level proceeds at a
slow rate usually not exceeding 10%.

2. Hyper /Run-away/Galloping inflation

Hyperinflation is one where the general price level increases at a very high rate, within hours,
days or weeks and the percentage point increase per annum is over 20%.
3. Walking inflation. This one where the general price level increases at a rate between 3% and
4% per annum.

CLASSIFICATION OF INFLATION ACCORDING TO CAUSES:

1. DEMAND-PULL INFLATION
Demand-pull inflation refers to persistent increase in the general price level that arises due to
excess aggregate demand over aggregate supply at full employment level of resources.

Causes of demand-pull inflation in Uganda:

 Excessive issuance of currency by central bank which is not followed by increase in the
level of output.
 Excessive recurrent government expenditure on non productive activities/ventures
leading to increased money supply.
 Excessive inflows of incomes from abroad in the form remittances by nationals living
abroad.
 Excessive exportation of essential goods/Increasing demand for our exports.
 Excessive /Uncontrolled credit creation by commercial banks.

SOLUTIONS TO DEMAND-PULL INFLATION:

 Control wages and incomes of the people (wage freeze).
 Reduction in government expenditure especially on non-productive ventures
 Importation of goods from cheaper sources to supplement domestic output

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  Discourage exportation of scarce goods to avoid shortages.
 Increase direct taxes in order to reduce people’s incomes.
 Apply restrictive monetary policy i.e. where the government withdraws excessive money
in circulation.

2. COST-PUSH INFLATION:
Cost push inflation refers to persistent increase in the general price level that arises out of
increase in the costs production.
Cause of cost push inflation in Uganda:
 Increasing/rising costs of raw material of raw materials
 Increasing/rising wages/salaries
 Increasing/rising cost of transportation for raw materials from high fuel prices
 Increasing/rising level of taxation
 Increasing/Rising rate of interest on loans
 Increasing/rising costs of advertising

WAYS OF CONTROLING COST PUSH INFLATION:

 Provide subsidies to the producers/Reduce taxes charged on producers
 Adopt wage control measures to avoid unnecessary increase in wages
 Control interest rate in order to reduce the cost of borrowing.
 Adopt price control measures by fixing maximum prices

3. Price-Wage inflation. This occurs when an increase in prices of commodities induces

workers to demand for higher wages. This increases the costs of production and this leads
to continuous rise of prices all commodities.

NB: An inflationary spiral is a situation in which a persistent increase in the prices of goods
leads to the demand for higher wages by the workers causing increased costs of production
which results into increased costs of production which results into increased prices again
leading to increase demand for higher wages.
4. Wage price inflation. This occurs when the workers through their trade unions demand
for higher wages causing increased costs of production which forces employers to increase
prices for their products in order to maintain their profit margin.
5. The wage –wage inflation. This occurs due to inter-sector or inter-industry comparison
of wages by workers i.e. if workers in the similar type of employment are paid higher
wages. This makes their counterparts to demand for an increase in their wages leading to
increased production costs and higher prices for the good and services.
6. Profit Push inflation. This occurs due to too much desire for higher profits by
producers/traders which makes them put less output on the market hence forcing prices of
goods and services to increase.

7. STRUCTURAL /BOTTLENECK / SCARCITY INFLATION:

Structural inflation refers to persistent increase in the general price level /average price
level due to supply rigidities and structural bottleneck in the sectors of the economy
leading to a decline in the supply of essential goods.

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 OR: It is the type of inflation caused by supply rigidities and structural bottlenecks.
Causes of structural inflation:
 The breakdown of key industry
 Infrastructural break down
 Political instability/political turmoil
 Natural hazards e.g. floods, drought which reduces agricultural output
 Hoarding of goods by producers/traders
 Scarcity of inputs/scarcity of raw materials/limited raw materials
 There is foreign exchange shortages

Ways of controlling structural inflation:

 Maintain political stability in the country
 Rehabilitate infrastructure
 Undertake modernisation of agriculture

8. IMPORTED INFLATION:
This is the persistent increase in the general price level arising from the importation of
commodities from inflation prone countries or countries that are experiencing inflation.
OR: It is the type of inflation resulting from importation of goods from another country
experiencing inflation so that the high prices of imports result into rising prices of commodities
in the domestic market.

9. MONETARY INFLATION. This is the type of inflation caused by excessive increase in

money supply in the economy.
10. SECTORAL INFLATION: This refers to the rise in prices occurring in different
commercial sectors of a country.
11. PRICING POWER INFLATION/ADMINISTERED PRICE INFLATION /
OLIGOPOLSTIC INFLATION. This type of inflation occurs when business entities and
industries decide to increase the prices of their respective goods and services to increase their
profit margins.

GENERAL CAUSES OF INFLATION IN UGANDA.

 Break-down of infrastructures. The breakdown of railway and road services gives rise
to scarcity of commodities in many areas of the country. This is because it limits effective
movement of goods from areas of production to the market thereby causing prices to
increase thus causing inflation.

 Excessive issuance of currency. This leads to excessive money in circulation which is

not followed with an increase in production of goods and services. This consequently
results into too much money chasing too few commodities hence forcing prices to rise.

 Excessive government expenditure. Excessive government expenditure in form of

recurrent expenditure leads to increase in money supply in the hands of people which
eventually leads to excessive demand for goods and services hence forcing prices to
increase.

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 Poor political atmosphere/climate. This destroys productive infrastructure and scares
away investors due to fear of loss of lives and property, this limits production in industries
and agriculture sector and as a result, supply of commodities reduces. This forces the prices of
such goods to increase.

 Importation of goods from inflation prone countries/ Importation from countries

experiencing inflation. The importation of goods from countries experiencing inflation
forces importers/traders to increase prices for such goods in the importing country in
order to recover the heavy costs of importation and this causes inflation.

 Rising production costs (e.g. rising prices of raw materials, rising power tariffs, rising
interest rate, rising costs of transport, rising wages). Such costs force producers to
increase prices for their products sold to the final consumers in order to recover money
spent during production process hence cost push inflation.

 Greed for higher profits by traders, leading to profit push inflation. Too much desire
for higher profits by traders makes them put less output on the market hence forcing
prices of goods and services to increase.

 Speculation by traders and consumers. In some cases, traders anticipate increased

demand for their goods in future. Therefore, such traders deliberately hide or hoard goods
so that they create artificial shortages in future. After creating shortage of goods on the
market, they increase prices of goods and this causes inflation in the economy.

 Unfavourable natural factors/natural. Adverse natural conditions like a long dry

season, crop pests and diseases, floods e.tc greatly reduce supply of agricultural goods.
This creates a shortage of food items on the market. Finally, prices of food items increase
and this causes headline inflation.

Excessive exportation of essential goods/ increased demand for exports. There is

increased demand for essential goods like beans, maize, sugar, cooking oil e.t.c from Uganda in
the neighbouring countries such as Southern Sudan. This creates a scarcity of those goods in the
country forcing the prices to increase.

 Excessive/ Increasing inflow of incomes from abroad. This increases money in

circulation thus leading to excessive aggregate demand for goods and services hence
forcing prices to increase.

 Depreciation of the local currency relative to other currencies/ declining value of the
local currency relative to other foreign currencies. Depreciation of local currency makes
imports to be more expensive because it becomes costly to buy foreign currency which is needed
to import goods from other countries. This forces the importers to increase prices of imported
goods thereby causing inflation.

 Excessive/Uncontrolled credit creation by commercial banks. Uncontrolled lending

of money to the public by commercial banks creates excessive money supply in the

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 country without corresponding increase in the volume of goods and service hence forcing
prices to rise/increase.

 Excessive borrowing of money from the central bank by the government. The
government borrows money from the central bank to finance its deficit budget. This is
done by instructing the Central bank to print and issue more money to Government
ministries. This creates an increase in liquidity in the economy which increases people’s
purchasing power and aggregate demand for goods and services. This gives rise to
inflation in Uganda.

MEASURES TO REDUCE INFLATION:

 Increase direct taxes on incomes of the people. This reduces disposable income and
purchasing power which eventually reduces aggregate demand and thus forcing prices of
goods and services to fall.

 Reduce government expenditure on provision of non-essential goods in order to

reduce money supply and control aggregate demand. This is intended to reduce
expenditure on provision of non-essential goods and services which reduces the amount of
money in circulation and thus reducing excessive aggregate demand over supply, thus
checking inflation.

 Further liberalisation of economy. This involves remove of unnecessary controls on

economic activities, which helps to increase domestic production hence controlling
structural inflation.

 Improve/Develop infrastructural facilities. This is intended to encourage production

due to ease of transportation of raw material goods to production units and also
transportation of fished goods to the market. This reduces structural inflation.

 Further privatisation of state enterprises. Privatisation reduces/ controls structural

inflation because privatized enterprises increase supply of goods and services due to better
management and improved technology.

 Control issuance of currency. This reduces money supply and as a result the public has
less money in their hands which forces prices to fall.

 Provide investment/tax incentives to the investors. This helps to increase production of

goods of goods and services due to reduced cost of production leading to their increased
supply, thus leading to a fall in the prices of such goods.

 Use of contractionary / restrictive monetary policy for example through sale of

government securities. This is intended to reduce the amount of money in circulation
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 which reduces the aggregate demand for goods and services and thus leading to a fall in
the general price levels.
 Improve political climate /Atmosphere. By ensuring political stability, investment in
industries, agriculture and other sectors is also promoted since investors are not scared of
losing their lives and property; this leads more production of goods and services thus
reducing scarcity of such goods thereby controlling inflation.
 Modernisation agriculture. This leads to increased production of food items thus
reducing scarcity and thus controlling inflation.

 Reduce indirect taxes on essential goods and services. This helps to reduce the cost of
production and therefore the producers also reduce the prices of goods and services.

 Encourage importation from cheaper sources. This policy helps to avoid buying goods
from countries hit by inflation thereby reducing imported inflation.
Encourage establishment of import substitution industries. These industries are
producing more consumer goods that were formerly imported. This is minimises the
possibilities of importing goods from countries experiencing inflation since these are
domestically produced and thus controlling demand pull inflation.

 Encourage use of instruments of credit for example cheques, promissory notes, bills
of exchange and credit cards. Instruments of credit are intended to reduce cash
transactions since it reduces the volume of paper notes and coins thereby reducing excess
aggregate demand over supply thus controlling inflation.

 Control the exportation of essential goods/certain goods. This ensures large domestic
supply of such goods and thus forcing prices to fall.

 Reduce government borrowing from the central bank . This reduces the amount of
money in circulation hence reducing peoples’ purchasing power thus forcing prices to fall.

EFFECTS /IMPACT/CONSEQUENCES/OUTCOMES OF INFLATION IN AN

ECONOMY

Inflation is associated with both positive and negative effects in an economy.

The positive effects/ outcomes are generated from the mild or creeping or gradual form
of inflation.

The negative effects/consequences are generated from the Hyper or Run-away or

Galloping inflation.

N.B: Therefore whenever a question is asking for the effects of hyper or run –away or
galloping inflation we only consider the negative effects of inflation.

POSITIVE EFFECTS OF INFLATION IN AN EC.ONOMY.

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  It encourages/stimulates effort and hard work. People are stimulated to carry out
economic activities in order to earn income and be able to buy those goods whose prices
are slowly rising i.e. people work hard to get money in order to meet the slowly rising
cost of living.
.
 It is an incentive for investment and production. Mild inflation leads to a slight
increase in the profits of producers because goods are being sold at slightly higher prices.
Consequently, investment and production are stimulated leading to higher Gross
domestic product
 Producers tend to increase output in order to earn more profits. Mild inflation
encourages producers to increase the levels of output of goods and services in order to
benefit from increasing profits
 More employment opportunities are created. Since investors are getting higher profits
from the gradual inflation, they are able to expand their investments and this promotes
the creation of more jobs for the people.
 It helps to increase government revenue. Due to the rising prices of commodities,
business companies earn more profits; the government taxes such profits thus increasing
her revenue.

 It encourages/Increases resources utilisation. Mild inflation promotes investment. As a

result, production increases and this makes the producers or investors to utilize those
resources that would have remained idle.
 It encourages innovativeness and creativity among the people/Stimulates
entrepreneurship. Mild inflation is associated with a slight increase in profits of traders.
This encourages people to become risk takers and they set up income generating
businesses so that they have something to sell and get the profits

 The borrowers/debtors gain in real terms. At the time of borrowing, the value of
money is still high and the borrower uses the money to buy more goods from the market.
However, by the time the borrower pays back the money its value will have gone down
but he/she would have gained in real terms.

 It promotes commercialisation/ monetisation of the economy. This is so because

producers are attracted by the high profits to produce for the market.
 It increases the level of output, thus stimulates economic growth
 It encourages labour mobility. Labour is encouraged to move either from one job to
another or from area to another in such of high paying jobs so as to meet the rising cost of
living.
 It increases levels of output/ promoting economic growth. This is because producers
increase output so as to gain from the high profits resulting the slowly rising prices.

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 It helps the economy to recover from an economic depression. During periods of
Mild, there is a gradual increase in incomes of producers. The producers increase
investment and output also increases thereby enabling an economy to recover from a
depression.

It helps an economy to recover from a depression. During periods of Mild or gradual

inflation, there is a gradual increase in incomes of producers. The producers increase
investment and output also increases thereby enabling an economy to recover from a
depression

 It promotes forced savings. Due to increasing prices, consumers are forced to reduce on
consumption of certain goods especially on non essential goods due to the rising prices of
such goods.

NEGATIVE EFFECTS OF INFLATION IN AN ECONOMY:

Note (These are generated by focusing at or considering only hyper inflation):

 It discourages savings. People fear to save money because its value is falling at a very
fast rate. If money is saved, it is of very little use in the future when its value is very low
 It leads to loss of confidence in the country’s currency. Inflation leads to loss of
confidence in a currency as a medium of because the public considers it to be worthless
since it loses its function as a store of value and thus the public finally resorts to barter
trade.
 It worsens the balance of payment problem/ deficit. Foreign investors repatriate their
profits because they fear to re-invest such profits in a country hit by hyper inflation. This
cause’s significant outflow of capital which worsens the balance of payment position of a
country.

 It leads to industrial unrest/strikes. This arises because trade unions respond to the
hyper inflation by agitating for an increase in wages of their members. They may
organize sit down strikes to force employers to increase wages of their members hence
creating industrial unrest.
 It worsens income and wealth inequalities/Worsens income inequalities. Hyper inflation
benefits the businessmen because they earn more by selling their merchandise than other
people receiving fixed incomes and allowances.

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  It discourages local and foreign investors. Potential investors are not willing to
invest in an economy suffering from hyper inflation; this is due to high cost of
production which reduces the profit levels.
 It leads to unemployment. Due to hyper inflation, production costs rise at a very
high rate which forces some firms to close down due to reduced profit levels, thus
leading to unemployment.
 It makes the government unpopular. A very high rate of inflation creates a sharp
rise in the cost of living. This brings about misery, suffering and discontent among
the population. The public develops hatred against the government in power.

 It leads to production and consumption of poor quality goods. In an attempt by

the producers to cut the costs of production some ingredients in the production of
certain products are left out, this leads to production and consumption of poor quality
products.

 It makes planning difficult/distorts planning. Due to hyper inflation the money

previously set aside by government to finance development plans become
insufficient. This makes government to abandon some plans and they are not
implemented hence limiting economic growth.
 The fixed income earners lose/suffer greatly as real income reduces. Those individuals
who earn fixed incomes suffer due to the rising cost of living. They continue to
receive the same amount of nominal income yet prices of goods and services are
rising at a very high rate this greatly reduces their purchasing power.

 Discourages lending as Creditors/Lenders are paid back less in real terms than
they lent out. The lenders get back their money from the borrowers when it has a
lower purchasing power than that at the time of lending. Financial institutions such as
commercial banks are reluctant to lend out money to people during periods of hyper
inflation,
 It encourages/ promotes malpractices/illegal activities. People look for possible
opportunities of supplementing their fixed incomes through illegal means such as
corruption, prostitution, so that they get additional money to make them survive
amidst the high cost of living created by hyper inflation.

 People are strained in an attempt to cope with the rising cost of living. People tend to
forego leisure and take on additional income generating activities to supplement what
they are currently earning. This greatly lowers the welfare of the people as they become
physically and mentally strained.
 It leads to brain drain. Highly trained people migrate from a country hit by hyper inflation
to look for jobs in other countries where prices are lower where cost of living is lower.
This results into loss of highly skilled manpower.

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REASONS FOR KEEPING A LOW RATE OF INFLATION IN AN ECONOMY:

 To promote savings in an economy.

 To promote people’s confidence in the local currency.
 To enable fixed income earners enjoy a better standard of living.
 To encourage lending by financial institutions so as to expand investment.
 To reduce unemployment in a country.
 To facilitate or ease economic development planning.
 To encourage local and foreign investors.
 In order to reduce income inequality.
 To reduce brain drain
 To ensure that people are less strained since the cost of living is low.
 To discourage illegal activities
 In order to make the government in power popular among the public so as to reduce civil
unrest.
 To reduce industrial unrest.
 To discourage capital outflows/ to improve B.O.P position.
 In order to ensure production of high quality goods.

CIRCUMSTANCES UNDER WHICH INFLATION MAY BE DESIRABLE IN AN

ECONOMY:
N.B: We extract the circumstances from the positive effects of inflation. The presentation of
points must be in a conditional statement. Therefore begin with:
 When …………………………………………………………
 In case ……………………………………………………….

 When it promotes economic growth. The existence of mild inflation encourages

producers to increase output in order to sell more goods and services so as to make
higher profits. The increase in output brings about higher levels of economic growth.
 When it results into an increase in the profits of producers. When traders increase
prices of goods which they sell to consumers, they earn more profits and this makes
inflation to be desired by traders in an economy
 When it stimulates inventions and innovations / when it encourages hard work
among people. The rising cost of living created by inflation makes the public to be
creative and hard working so as to receive money and be able to survive during
periods of inflation. Many people become entrepreneurs and they take risks in
business enterprises hence making inflation to be desirable.
 When it helps to reduce voluntary unemployment among people. Inflation
increases the cost of living and this forces people to engage in income generating
projects in order to earn income thereby reducing voluntary unemployment.
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  When it promotes investment levels /when it promotes utilization of resources.
Since producers desire to make more profits during periods of inflation, they may
expand their investments. The expansion in investments as a result of inflation leads
to the use of resources which would have remained idle hence making inflation to be
desired in an economy.
 When it helps an economy to overcome a depression. When mild inflation exists in
an economy, it encourages producers to increase production. Incomes of producers
increase and they are able to undertake further investment. This may pull an economy
out of a depression and inflation becomes desirable.
 When it promotes forced savings. The existence of inflation may compel
government to encourage people to start saving part of their income through
compulsory saving schemes. The money saved will be available for future use by
savers and this makes inflation to be desired in economy.
 When it benefits the borrowers in an economy. Inflation is good to the borrowers
because they borrow money when it still has a higher value and pay back when its
value is lower. Therefore by the time borrowers pay back the money, they will have
put it to more profitable use and this makes inflation to be desired in an economy.
 When it encourages labour mobility in an economy. The existence of inflation
encourages people to change either from one occupation to another or from one
geographical area to another to seek for better paying jobs so as to catch up with the
rising cost of living.

THE CONCEPT OF STAGFLATION:

This is a situation in an economy in which high rates of inflation co-exists with high
levels of unemployment.

Costs/Demerits of stagflation to an economy:

 It leads to high costs of living due to increased prices
 It leads to a decline in people’s welfare due to rising prices of goods and services and
high unemployment levels
 It leads to a decline in the rate of savings due to low incomes and high rate inflation
 It leads t loss of confidence in the country’s currency as a medium of exchange
 It widens income inequality
 It discourages investment due to high cost of borrowing
 It leads to social tension which results in civil strife.

MEASURES OF REDUCING STAGFLATION:

 Reduce taxes to encourage investment
 Liberailse the economy
 Subsisidise producers to reduce production costs and thus promote investment
 Increase government on production and investment activities.

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 RELATIONSHIP BETWEEN INFLATION AND UNEMPLOYMENT:
 High rates of inflation discourage savings and investment thus causing unemployment.
 High level of unemployment of resources may lead to low production hence inflation.
 High level of inflation leads to high demand for wages making employers adopt capital
intensive methods hence less demand for labour, causing unemployment.
 High inflationary rates reduce the level of aggregate demand hence unemployment of
resources especially labour.
 Fighting inflation through reduced government expenditure limits the funds available for
investment leading to unemployment

THEORIES OF INFLATION:

 MONETARY THEORY OF INFLATION: This argues that if the money supply rises
faster than the rate of growth of national income then there will be inflation.
 DEMAND PULL THEORY OF INFLATION. According to Lord J.M .Keynes,
inflation is caused by excessive demand that is not matched with supply. Increase in
aggregate demand without increase in aggregate supply forces prices of to shoot up
leading to inflation
OR: According to this theory, inflation occurs when demand for goods and services
exceed existing supplies.
 COST PUSH THEORY OF INFLATION. This suggests that inflation results primarily
from the increase in the production costs usually by rising raw material prices, excessive
wage increase from trade union pressure. etc.
 THE STRUCTURALISTS THEORY OF INFLATION. According to the
structuralists, inflation is caused by a structural breakdown of the economy either due to
bad economic policies, wars, and poor harvests in the agricultural sector caused by
unfavourable natural factors.
OR: According to the structuralists, inflation results from supply rigidities and supply
bottlenecks.

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