Money Banking and Finance

Topic: Inflation, Deflation and Stagflation

By: Riaz Hussain Ansari

Lecturer Department of Business Administration
University of Sahiwal

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Learning Objectives

You will be able:

What is Inflation.

Discuss what is stagflation.

Distinguish between demand full and cost

push inflation.
Devaluation and its effects on the economy.

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 What is Inflation, Its Causes
 Inflation is a term which is known to most of us. It
is also criticized by many of us. It is feared by all
of us. But it is not understood by majority of us.

 Inflation is a continued upward movement in the

general level of prices.

 By inflation is meant a steady and sustained rise

in the prices.

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 Causes of Inflation
Demand Pull Inflation
Demand pull inflation is also called Aggregate Demand
Inflation.

Sources of rises in aggregate demand

Inflation is always and everywhere a monetary
phenomenon

Continues Continues Continues

increase in the increase in inflation
money supply aggregate
demand

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 Causes of Inflation
(a) Demand Pull Inflation
and Full Employed
If the country’s resources are
fully employed and there is an
increase in aggregate demand
for goods. It will lead to an
upward movement in prices.
(b) Demand pull inflation at less than full employment
An increase in aggregate demand can result in a rise in the general
price level at less than full employment.

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 Causes of Inflation

(a) Cost push inflation:

Increase in money wage rates
Profit push inflation

Materials push inflation

Higher taxes

Rice in import prices

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 Remedies of Inflation
Monetary Policy
Monetary policy is a policy that influences, the economy
through changes in the money supply and available credit. The
various monetary measures which are used to control inflation
are grouped under two heads
Quantitative Controls

Qualitative Controls

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 Remedies of Inflation
Fiscal Policy
Changes in Taxation
Chances in Govt. Expenditure

Public borrowing

Balances budget changes

Control of deficit financing

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 Remedies of Inflation
Others Measures
Price Support program
Provision of subsidies

Arrangements of easy availability of Goods on hire purchase

to stimulate demand.
Imposing direct control on prices of essential items

Rationing of essential consumer goods in case of acute

emergency holding of Friday and Sunday markets.

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 Reflation
Others Measures
A real inflation is a sustained rise
in the general level of prices. It is a
situation of rising prices after the
full employment is reached. It is in
fact a phenomenon of rising prices
due to increase in aggregation
demand without any increase in
production of goods and
employment.

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 Reflation
Others Measures
In inflation and reflation both, the money supply increases.
Both result in the upward movement of general price level.

The different between inflation and reflation are

Inflation poses a serious problem of rising prices without any

increase in output and employment.

In reflation, there is a moderate continuous rise in the price

level leading to more production and employment.

Reflation is adopted by the government as a deliberate policy

Price rise very slowly under reflation; whereas there is rapid

increase in the general level of prices under inflation.

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 Disinflation
There are no adverse effects of disinflation. It rather
saves the economy from the ill effects of inflation.
Disinflation is always the direct result of deliberate policy
of the government.
Disinflation occurs after the level of full employment is
reached in he economy.

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 Meaning of Stagflation
In the words of Samuelson”, stagflation involves
inflationary rise in prices and wages at the same time.
The people are unable to find jobs and films are unable
to find customers for what their plants can produce.

Causes of Stagflation
There are a number of causes which explain the
phenomenon of stagflation. They are not only manifold
but also interlinked. The modern developments in
explaining the causes of stagflation are as under.

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Reduction in aggregate supply

 Causes of Stagflation: Reduction in aggregate supply

may be due to rise in resource costs, price of raw material, rise
in wage rates, imported material. The rise in resource cost leads
to rise in prices and reduction in output.
 Reduction in labor supply: Reduction in labor supply
adversely affects output of goods. If the reduction in labor supply
is caused by a rise in money wages on account of strong union
or by a rise in the legal minimum wage rate, there will be a fail in
output and employment and the price level rises.
 Increase in Taxes: If there is rapid increase in indirect
taxes, it will raise costs and prices of domestic goods and reduce
output and employment.

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Reduction in aggregate supply

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Measures to Control Stagflation
 The government should make every effort that minimum
wages are not raised during stagflation.
 The firms which cooperate and maintain the wages below the
target rates should be properly rewarded by giving concession
and reduction in business income tax. Those which allow wage
increase above the target rates should be asked to pay
penalty tax in addition to the normal business tax.
 The increase in money wages should be linked with increase
in productivity.
 The personal and business taxes should be reduced to bring
down the costs of goods.
 Through manpower training, the supply of labor should be
upgraded. This will help in reducing unemployment.

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Measures to Control Stagflation Cont’d

 Transaction should be improved to provide facilities for

searching out jobs in production areas.
 The government itself should take up development programs
to create jobs in the country.

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 Kinds of Inflation

(a) On the Basis of Rate of Inflation

Creeping Inflation

Walking Inflation

Running Inflation

Galloping or Hyper Inflation

(b) On the Basis of Degree of Control

Open Inflation

Suppressed Inflation

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 Kinds of Inflation

(c) Inflation on the Basis of Causes

Demand pull Inflation
Cost push Inflation

Profit reduced Inflation

Budgetary Inflation

Monetary Inflation

Multi Casual Inflation

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 Kinds of Inflation

(d) On the basis of employment

Partial Inflation

Full Inflation

(e) Anticipated verses unanticipated Inflation

Rate of inflation which majority of inflation believe will

occur.
Which comes as a surprise to majority of individuals.

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 Inflation Vs Deflation
Inflation  Price mechanism
As we know, is a state of rising prices
 Outflow of capital
over a long period of time. A rapid  Debtor Gains
increase in prices has adverse effect  Break down of the
on the economy. monetary system of the
Purchasing power country
Sort of artificial prosperity  The exports deadline
Increase the inequalities due
Investment in the economy

Diversion of resources

Encourages hoarding

Stimulates speculative activities

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 Inflation Vs Deflation cont’d
Deflation
Deflation is a situation whereby prices are failing resulting in the
deadline of output and employment in the economy. Deflation is
condemned in following groups.
Due to fail in prices, the profit margin deadlines. There is

considerable decrease in output and employment.

Creditors no doubt gain during falling prices but they also have

great risk of losing all or part of the money.

The rate of interest is pushed down as saving exceeds investment

during falling prices.

The persons with fixed income such as salary earners, pensioners,

etc gain during deflation.

The farming class suffers during deflations as the cost of inputs

remain higher than prices of farm products.

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 Inflation Vs Deflation Cont’d
Deflation
Deflation creates a fear of poverty and results in general
demoralization of the community.
It disturbs the stability of the economy and hampers economic

development. It is therefore the worse evil.

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Inflation in Pakistan

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Causes of Inflation in Pakistan
Demand Pull Inflation
Demand for non development expenditures.
Rapid Monetary Expansion.

Deficit Financing

Increase in Workers remittances.

Foreign Economic Assistance

Consumption Habits

Construction of Houses

Excessive speculation and hoarding

Increase in wages

Population explosion

Black Money

Ch 1 -25
Causes of Inflation in Pakistan
Cost Push Inflation
Increase in wages
Rising prices of imported goods

Increase in indirect taxes

Rise in POL, Gas, Excise Duty

Rise in support prices of agriculture crops.

Price Stabilization measures in Pakistan.

Increase in the supply of essential goods

Supply of essential items through utility stores.

Cash reserve ratio

Open market operation

The market mechanism

Subsidy is being produced

Ch 1 -26
 Devaluation of Money

Meaning of Money
By devaluation is meant the reducing of value or
exchange rate of national currency with respect to other
foreign currencies.
If the economy operating under a fixed exchange rate
and it officially lowers the price of its currency in foreign
exchange markets, it is referred to as devaluation

Ch 1 -27
 Devaluation of Money
Motives of Devaluation in Pakistan
Its stimulates exports of commodities.
It restricts import demand for goods and services.

It helps in creating a favorable balance of payments.

World Motives of Devaluation

Correcting over-valuation of currencies.
Embarking upon an anti-deflationary programme by monetary and

fiscal expansion.
Encouraging experts and shrinking imports so that a favorable

balance of payment is achieved

Effects of Exchange rate adjustments

Ch 1 -28
 Enforceability
 Every contract is an agreement, but every
agreement is not always a contract. An agreement
creating a legal obligation is said to be
enforceable by law. The parties to an agreement
must be bound to perform their promises and in
case of default by either of them, must intend to
sue. For an agreement to be enforceable by law
there should be legal obligation instead of social,
moral or religious obligation.

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 Enforceability Instance
 A, offers to sell his furniture to B or Rs.
50,000. B accepts this offer. In this
agreement if there is default by either party,
an action for breach of contract can be
enforced through a court of law provided all
the essential elements of a valid contract are
present in this agreement.

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Essentials of a valid contract

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 Essentials of a valid contract

 Offer and acceptance

 There must be an agreement between parties to
create a valid contract. An agreement involves a valid
offer and its acceptance.
 A offers to buy bike from B for Rs.50,000 to which B responds
positively. Here A has made an offer and B has accepted

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 Essentials of a valid contract

 Legal relationship
 A contract to become valid must have a legal relationship. In
case of social or domestic agreements, the usual presumption is
that the parties do not intend to create legal relationship but in
commercial or business agreements, the usual presumption is
that the parties intend to create legal relationship unless
otherwise agreed upon.
 A invited B on a dinner at his home. B accepted the invitation. It is a
social agreement. If A fails to serve dinner to B than B cannot go to
court for enforcing the agreement and similarly if B did not turn up
than A cannot go to court for enforcing the agreement.

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 Essentials of a valid contract
 Competency of parties
 As per section 11 the parties to an agreement
must be competent to contract. In other words,
the person must be of
 The age of majority
 Person of sound mind and
 Not declared as disqualified from contracting by any
law to which he is subject.
Example: A (Minor) borrowed Rs. 100,000 from B and executed
mortgage of his property in favor of the lender. This is not a valid contract
because A is not competent to contract.

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 Essentials of a valid contract

 Consideration
 As per section 23 an agreement must be supported by
lawful consideration. Gratuitous (without consideration)
promises are not enforceable at law. Consideration
requires not only presence of consideration but also
lawfulness of consideration.
Example
A offers to buy IPAD from B for Rs. 50,000 to which B
responds positively. Here A’s promise to pay Rs. 50,000
is the consideration for B’s promise and B’s promise to
sell the IPAD is the consideration for A’s promise.
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 Essentials of a valid contract

 Free Consent
 As per section 14 an agreement must be made between parties
by free consent. In other words, the consent must not be
obtained from following:
 Coercion

 Undue influence

 Fraud

 Misrepresentation

 Mistake

 Example: A beats B and compels him to sell his bike for Rs.
20,000. Here, B’s consent has been obtained by coercion
because beating someone is an offence under the Pakistan Penal
code
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 Essentials of a valid contract

 Lawful Object
 As per section 23 the object of an agreement must be
lawful. An object is said to be unlawful when:
 It is forbidden by law
 Is of such a nature that if permitted would defeat the
provisions of any law
 it is fraudulent
 It involves an injury to the person or property of another
 The court regards it as immoral, or opposed to public
policy

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 Essentials of a valid contract

 Not declared as void

 As per section 24 to 30 an agreement which is not
enforceable by law is called void agreement. There
are certain agreements which have been expressly
declared as void such as:
 Agreement, the consideration or object of which is partly unlawful
 Agreement made without consideration
 Agreement in restraint of marriage
 Agreement in restraint of legal proceedings
 Agreement in restraint of trade
 Uncertain agreements
 Wagering agreement
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 Essentials of a valid contract

 Certainty
 As per section 29 an agreement may be void on the grounds of
uncertainty. The meaning of the agreement must be certain or
capable of being certain.
 Example: A agrees to sell to B "a hundred ton of oil." There is

nothing whatever to show what kind of oil was intended. The

agreement is void for uncertainty.

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 Essentials of a valid contract

 Possibility of performance
 As per section 56 the terms of the agreement must be capable of
being performed. An agreement to do an act impossible in itself is
void.
 Example: A agrees with B to discover treasure by magic. The agreement is
void.

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 Essentials of a valid contract

 Legal Formalities
 As per section 25 an oral contract is a
perfectly valid contract, except in certain cases
where a contract must comply with the
necessary formalities as to writing, registration
etc.
 Example: An oral agreement for arbitration about present
disputes is unenforceable because the law requires that such
arbitration agreement must be in writing.

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Kinds Of Contract

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 Knowledge (Cont’d)

 Formation of Contract
 Express contracts A contract created by
words i.e. verbally or in writing
 Implied contracts A contract created by
conduct of a person or the circumstances of a
particular case.
 Quasi contracts An obligation imposed by
law.

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 Knowledge (Cont’d)

 Enforceability of Contract
 Valid contract An agreement which is enforceable by law.
 Void agreement Section 2(g) An agreement which is not enforecable by
law.
 Void contract Section 2(j) A contract which ceases to be enforceable
by law becomes void when it ceases to be enforceable.
 Voidable contract Section 2(i) An agreement which is enforceable by
law at the option of the aggrieved party.
 Illegal agreements An agreement the object of which is illegal.
 Unenforecable agreement An agreement which is otherwise valid but
due to some technical lacking, such as writing etc. remains
unenforceable.

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 Knowledge (Cont’d)

 Performance of Contract
 Executed contract A contract where both the parties have
performed their respective promises.
 Executory contract A contract in which something remains to be
done.
 Unilateral contract A contract is which a promise on one side is
exchanged for an act on the other side. In such contract one
party to a contract has performed his part and performance is
outstanding against the other party.
 Bilateral contract A contract in which a promise on one side is
exchanged for a promise on the other.

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Any Question?

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Many Thanks

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