effects and solutions for inflation

8/3/2019 Effects and Solutions for Inflation

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Effects of Inflation1. Aggregate demand and supply:

The net effects of inflation depend on the nature and strengths of effects on aggregate demandand supply. Inflation affects aggregate demand through a number of distinct ways.

y First, inflation affects investment activities in the economy by creating uncertainty about

the future evolution of output and input prices and profitability.y Second, inflation exerts negative effect on consumer spending by reducing the real value

of consumer wealth.

y Third, it can reduce the real value of government expenditure, which is an importantcomponent of aggregate demand, particularly in developing countries.

y Fourth, inflation affects economic activities by promoting imports through increase indomestic prices relative to foreign prices. .

Inflation also influences the aggregate supply situation in many ways.

y First, inflationary expectations encourage firms to carry larger inventories and stocks than

necessary besides buying plant and equipment sooner than really necessary.

y Second, human resources are diverted from efficient management and production towardsmaneuvering and speculation to benefit from inflation.

y Third, long-term contracts are discouraged and resources are wasted on frequent negotiations.

y Fourth, market information becomes less useful with inflation as every transaction requires new

information gathering.

y Finally, agents excessively and needlessly economize on use of deposit balances in order not to

hold depreciating money and requiring more frequent settlement of accounts.

2. Rise in commodity prices:

When core inflation rises the prices of all items, excluding food items and energy, increase andmainly impact the cost of construction, land prices, and other sectors making the common man¶s life more

difficult. The Economic Survey of Pakistan 2010/11 reckons, that overall food imports accounted for 13.5% of total imports in July,-March 2010/11. The floods and sporadic rains, weak currency, flatteningyield growth of major crops, low productivity gains, increasing costs of agriculture inputs, populationsyndrome, energy shortage, and stocking of essential items, are further feeding into inflationary pressure.



(K han, 2010-2011)

3. Lack of development

During an inflationary period it becomes very difficult for the government to fulfill its commitments of achieving macro economic targets. Almost all targets, such as GDP growth, price inflation, bank borrowing, trade deficit, budget deficit, are violated. This hurts the credibility of the government. Costs of development project and non-development expenditure increase due to which the government needs morefunds next year by the amount of inflation to keep economic activity at the level of previous year.

4. Increase in equality of wealth concentration.The fruits of the bubbles were usurped by a clique of rich businessmen, speculators and inside-traders

who drove the stock market to historical highs, along with real estate prices, while the condition of

middle-class and poor Pakistanis deteriorated.

Redistribution of income takes place during an inflationary regime. Resources are moving from lender to

borrower. As in the case of Pakistan, lenders are small deposit holders and borrowers the rich elite.

Double digit inflation is aggravating the already high inequality between the rich and the poor.

5. Cost of living increases:

Cost of Living Adjustment Allowance or inflation adjusted increments and minimum wage law arehelpful measures to hedge against inflation, annual increments.

6. Decrease in saving:

A low saying rate in the country is also one of the causes of rising inflation. In the wake of 14%

inflation and an average 10% deposit rates, depositors are getting negative real rates of return on

their deposits. Income of the individuals is being diverted from saving to consumption and non-

productive channels like purchase of real estate and conspicuous consumption leaving saving at a

very low level of 11% in the country.

7. Expensive Imports:

Dollarization; as defined by the ratio of foreign currency deposits to total monetary assets (M2),

takes place due to the decline in the value of domestic currency. Foreign currency deposits in Pakistan

have reached the $9.4 billion mark since their inception in 1992 to date acting as a hanging sword on the



head of the government. Inflation expedites this trend further. Due to this the imports are more expensive

than the exports.

8. Devaluation of currency:

Devaluation is also one of the consequences of inflation. Due to double digit inflation Pakistan has been

caught in the vicious circle of devaluation (devaluation inflation loss of competitiveness again

devaluation).

9. Supply shocks There has been a significant rise in inflation mainly caused by supply shocks of essential food items and

higher crude oil prices in the international market. Some essential items like wheat and meat has

witnessed considerable increase mainly spearheaded by supply shocks caused by misadministration and

hoarding (rather than actual supply shocks)..

10. Inflation and Employment:

There are always some sort of trade-offs between employment and inflation.

11. Oil prices in international market:

Another important contributor to the inflation was higher oil prices in the international market. Higher the

foreign prices in oil market, higher will be the domestic prices of oil and thus increasing inflation.

The government is cautious about inflation and thus has taken various steps to release demand pressures

on the one hand and enhance supplies of essential commodities on the other. To ease demand pressures,

the State Bank of Pakistan (SBP) has continuously tightened the monetary policy over the last three years

and more so in the current fiscal year, while to enhance supplies, the government has relaxed its import

regime and allowed imports of several essential items so that there is a continuous flow in the supply of

those important commodities. In addition, the government increased the imports of items like wheat,

pulse and sugar to complement the efforts of the private sector. In order to provide relief to the common

man, the government also increased the scale of operations of the Utility Stores Corporation (USC) which

supplies essential commodities such as wheat flour, sugar, pulses and cooking oil/ ghee at less than the

market prices.

However by continuously printing money without the reserve gold to meet its debt is further causing

inflation.

Remedies:

The major factor towards excessive monetary growth in the case of Pakistan is high government

borrowing as compared to the stipulated credit allocation in the credit plan. This leaves less room for the

private sector which is considered more productive as compared to public sector. The Central Bank



should not act as the printing press for the government¶s finance ministry. Unlimited injection of credit

into the economy will aggravate the already uncontrollable inflation in the country. Quick and transparent

privatization of government sector enterprises and use of privatization proceeds towards debt retirement

will ease the government¶s position by reducing the amount of debt servicing. It will also lower the

government¶s budget deficit by the amount of losses incurred by these units.

1. Down-sizing the budget deficit by cutting administrative expenditures and through increases in

revenues by broadening the tax base.

2. There is need to provide credit to small farmers. His weak financial position and skill level

prevent him from employing modern equipment and inputs to his farm. It is no easy task for small

farmers in Pakistan to obtain credit from banks due to high interest rates.

3. Banks are unable to offer a positive real rate of return to depositors in Pakistan due to huge

intermediation costs and stuck up loans. Implementation of recently approved laws by the

parliament will help cure this situation.

4. Autonomy granted to State Bank Of Pakistan is also a right step towards financial soundness and

the restoration of the value of currency. Performance of the State Bank of Pakistan hinges on the

success of recovery drive, controlling monetary expansion to public sector for budgetary supportand reducing the lending rate by lowering the intermediation cost of the banking system.

5. Saving should be promoted so that more funds are provided for investment.

6. Change in Taxation System:-

The taxation system should be revised in order to encourage the private sector. Tax holidays

should be given to expand the industrial sector.

7. The import of luxury items must be restricted. It will protect us from international inflation and it

will be favorable for the balance of payment.

8. The taxation system should be revised in order to meet up with its debt obligations. Proper

taxation policies should be revised for agricultural sector.

9. Hoarding/stocking and black marketing should be controlled.

10. Cost of production should be decreased and indirect taxes should be removed.

Furthermore clear policies should be imposed and existing public sectors should be

improved



Asad, A. (2005). Inflation of Pakistan its causes and its remedies.

Khan, ,. A., Bukhari, S. K., & Ahmed, Q. M. (2006). determinants of recent inflation in Pakistan. Karachi

Pakistan.

Khan, A. (2010-2011). Economic survey of pakistan-Inflation. Pakistan: Government of Pakistan,ministry

of finance.

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