- LEADING CAUSES OF INFLATION
- FRAGILE ECONOMIC POLICES
- HOARDING, DISHONEST ATTITUDE OF TRADERS
- STEPS TO CHECK INFLATION
Inflation refers to a continuous, general increase in the price of goods and services. Rise in prices is called inflation. Inflation at very fast rate is Hyper-Inflation, medium is Strato-Inflation and low lever is Creeping inflation. During the recent years the rise has abnormal and it has endangered the stability of our economy nationally and individually. In Pakistan inflation has become an
unending disease to our economy. Once a state is caught in the circle of inflation then it will be difficult for that state to get rid of it.
There are various factors that contribute to the rise in prices. Some are natural factors like unfavorable weather conditions which affect the food production and lead to the shortage of commodities in the market. With more money chasing fewer goods, the prices take to the wings. Besides this natural problem there are man-made problems like hoarding which contribute to the rapid increase in prices. The trading community which senses a shorting of certain commodities, especially the essential commodities, they resort to large scale hoarding. They release the hoarding products after increase in the prices and make a neat margin over
their investment in the hoarded products. They get so much profit but it waters inflation.
The rise of prices in Pakistan can also be attribute to the despicable acts of traders. Their only motive is to get maximum profit and so they try to charge lots of money from the customers as much as possible. This has created a class of people who are becoming richer day by day and the other class is becoming poorer. Hoarding is also playing a bad role in escalation of prices in the commodities
One of the most important reasons for inflation is the deficit budgeting. In order to cover the gap Pakistan has been printing more paper currency because foreign aid and taxes can not cover up the deficit. Therefore there will be greater circulation of paper money. There will be hike in prices of domestic used products as the purchasing power of the people has increased. Wrong taxation policy has also been responsible for the rise in prices. The hike in taxes results in greater desire to avoid taxes. Thus public takes wrong way of not paying taxes and there will be escalation in prices.
Pakistan’s government has been making a great effort to check this inflation. The rate of interests has been increased in order to encourage savings and withdraw of currency. The government is making efforts to increase industrial outputs so that the level of consumption is leveled with that of output. But unfortunately the government has not met
with success in getting rid of inflation.
The rise in prices goes non-stopped, some suggest that there should be demonetization of currency, but the government
thinks that it is an irregular method and will create doubts in the minds of the public about the stability of the government. The rise in the prices of petrol has affected the prices in our country. Pakistan is not producing more than 20% of its total requirement of oil. So we have to import a huge amount of oil every year. Moreover no step has been taken against the traders who are
mainly responsible for unreasonable rise in the prices.
Inflation means there is a sustained increase in the price level. The main causes of inflation are either excess aggregate demand (economic growth too fast) or cost push factors (supply-side factors).
Summary of Main causes of inflation
- Demand-pull inflation – aggregate demand growing faster than aggregate supply (growth too rapid)
- Cost-push inflation – higher oil prices feeding through into higher costs
- Devaluation – increasing cost of imported goods, also boost to domestic demand
- Rising wages – higher wages increase firms costs and increase consumers’ disposable income to spend more.
- Expectations of inflation – causes workers to demand wage increases and firms to push up prices.
1. Demand-pull inflation
If the economy is at or close to full employment, then an increase in AD leads to an increase in the price level. As firms reach full capacity, they respond by putting up prices leading to inflation. Also, near full employment with labour shortages, workers can get higher wages which increase their spending power.
AD can increase due to an increase in any of its components C+I+G+X-M
We tend to get demand-pull inflation if economic growth is above the long-run trend rate of growth. The long-run trend rate of economic growth is the average sustainable rate of growth and is determined by the growth in productivity.
Example of demand-pull inflation in the UK
In the 1980s, the UK experienced rapid economic growth. The government cut interest rates and also cut taxes. House prices rose by up to 30% -fuelling a positive wealth effect and a rise in consumer confidence. This increased confidence led to higher spending, lower saving and an increase in borrowing. However, the rate of economic growth reached 5% a year – well above the UK’s long-run trend rate of 2.5 %. The result was a rise in inflation as firms could not meet demand. It also led to a current account deficit. You can read more about demand-pull inflation at the Lawson Boom of the 1980s.
2. Cost-push inflation
If there is an increase in the costs of firms, then businesses will pass this on to consumers. There will be a shift to the left in the AS.
Cost-push inflation can be caused by many factors
1. Rising wages
If trades unions can present a united front then they can bargain for higher wages. Rising wages are a key cause of cost push inflation because wages are the most significant cost for many firms. (higher wages may also contribute to rising demand)
2. Import prices
One-third of all goods are imported in the UK. If there is a devaluation, then import prices will become more expensive leading to an increase in inflation. A devaluation / depreciation means the Pound is worth less. Therefore we have to pay more to buy the same imported goods.
In 2011/12, the UK experienced a rise in cost-push inflation, partly due to the depreciation of the Pound against the Euro. (also due to higher taxes)
3. Raw material prices
The best example is the price of oil. If the oil price increase by 20% then this will have a significant impact on most goods in the economy and this will lead to cost-push inflation. E.g., in 1974 there was a spike in the price of oil causing a period of high inflation around the world.
4. Profit push inflation
When firms push up prices to get higher rates of inflation. This is more likely to occur during strong economic growth.
5. Declining productivity
If firms become less productive and allow costs to rise, this invariably leads to higher prices.
6. Higher taxes
If the government put up taxes, such as VAT and Excise duty, this will lead to higher prices, and therefore CPI will increase. However, these tax rises are likely to be one-off increases. There is even a measure of inflation (CPI-CT) which ignores the effect of temporary tax rises/decreases.
CPI-CT is less volatile because it ignores the effect of taxes. In 2010, some of the UK CPI inflation was due to rising taxes.
What else could cause inflation?
1. Rising house prices
Rising house prices do not directly cause inflation, but they can cause a positive wealth effect and encourage consumer-led economic growth. This can indirectly cause demand-pull inflation.
2. Printing more money
If the Central Bank prints more money, you would expect to see a rise in inflation. This is because the money supply plays an important role in determining prices. If there is more money chasing the same amount of goods, then prices will rise. Hyperinflation is usually caused by an extreme increase in the money supply.
However, in exceptional circumstances – such as liquidity trap/recession, it is possible to increase the money supply without causing inflation. This is because, in recession, an increase in the money supply may just be saved, e.g. banks don’t increase lending but just keep more bank reserves.
See: The link between money supply and inflation
Once inflation sets in it is difficult to reduce inflation. For example, higher prices will cause workers to demand higher wages causing a wage-price spiral. Therefore, expectations of inflation are important. If people expect high inflation, it tends to be self-serving.
The attitude of the monetary authorities is important; for example, if there was an increase in AD and the monetary authorities accommodated this by increasing the money supply then there would be a rise in the price level.
Last updated 7th June 2017.