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Transcript
Inflation & Its Measurements What we are going to learn today What is Inflation Introduction of inflation Definition of inflation Major Kinds of inflation Other kinds of inflation Measurements of inflation Assignment INFLATION ? Introduction Inflation is a process in which there is continuous increase in the general price level and the money is continuously losing its value. It may here be noted that rising general level of prices does not mean that the prices of all goods are necessarily rising. Even during inflation, prices of some goods may remain relatively constant. Definition of Inflation According to R.P Kent:Inflation is nothing more than a sharp upward movement in the price level. According to Crowther:Inflation is a state in which the value of money is falling i.e. prices are rising. According to Coulborn:In inflation, too much money chases too few goods. Major Kinds of Inflation Demand Pull Inflation Cost Push Inflation Demand Pull Inflation An inflation where aggregate(Total) demand for goods & services increases but aggregate(Total) supply of goods is constant. In other words when aggregate demand does not match with supply, it leads to increase in general price level e.g. increase in population etc. Diagrammed show S P2 P1 D2 D1 Cost Push Inflation An inflation, which occurs due to shortage in supply of goods and services. In this case demand is constant but supply falls due to increase in cost of production e.g. taxes on raw material ,war or floods etc. Diagrammed show S2 S1 P2 P1 D Characteristics of Inflation Increasing Prices Excess money Disequilibrium in demand & supply Other Kinds of Inflation Profit Inflation Income Inflation Deficit Inflation Production Inflation Wage Spiral Inflation Devaluation Inflation Profit Inflation Profit inflation is the result of greed of businessman. it usually occur in such economy which are dominated by monopolies. Monoplist is in a position to increase the price of his product at his will. As no substitute are available so people are forced to purchase his products at high prices. Thus it leads to exploitation of masses and inflation as well. Income Inflation The inflation that occurs from high income level is called income inflation. Income of masses may increase due to change in the salary structure of govt. are due to foreign remittances. In consumption oriented society where propensity to consume is higher than propensity to save such higher income will induce people to spend lavishly on consumer goods. This will add to the demand pull inflation. Deficit Inflation When revenues of government are less than its expenses govt. is said to run budget deficit. To overcome this deficit govt. make borrowings from both internal and external sources. the borrowing increase the govt. expenditures without producing corresponding increase in real output. This increase the supply of money in the economy. Higher supply induces more consumption causing price level to rise. Production Inflation Production inflation arises due to lack of capital projects. If the process of industrialization is slow as compare to the rate of growth of population, then soon the economy would be unable to meet all the needs of its members. Shortage of various goods will motivate supplier or stockiest to force up prices. Devaluation Inflation Devaluation leads to inflation. ( However, many economists are of the view that it is inflation which leads to Devaluation). Devaluation makes our currency cheap in term of foreign currency. It also makes all those goods cheap which are priced in rupees. Consequently exports price fall and import prices rise. Higher imported price of raw material increases domestic cost of production causing inflation. Causes of inflation Demand Pull Inflation Cost Push Inflation Causes of Inflation In Pakistan Deficit Financing Devaluation Decrease in Production Population Explosion Increase in Wages Increase in Export of Consumer goods Oil Crisis Increase in Indirect Taxation Natural Climates Psychological Factors Social Evils Causes of Inflation In Pakistan Deficit Financing The govt. may prepare deficit budgets to complete its various projects. A large part of development expenditure is done out of deficit financing, which increase supply of money. Devaluation Devaluation brings inflation due to rise in the prices of imports, increases purchasing power of exporters, more exports and low imports, Psychological factors. Causes of Inflation In Pakistan Decrease in Production Due to agricultural and industrial backwardness there is shortage of commodities in the country. So prices are increased which creates inflation in the country. Population Explosion In Pakistan population is increased at the rate of about 2.1%. The pressure of population has increased the aggregate demand, which leads to inflation. Consumption Habits People of countries like Pakistan are mostly spendthrifts. Such consumption trends generate artificial shortages of resources and causes inflation. Causes of Inflation In Pakistan Increase in Wages The rise in wages, salaries increases the purchasing power of the people. Wages and prices chase each other. When wages are increase then prices are also increased. This will cause inflation. Increase in Export of Consumer goods Due to increase in export of consumer goods & raw goods to foreign market, the quantity of goods is decreased in the country. Therefore general price level is increased. Oil Crisis The oil crisis in 1973 created a large quantity of inflation throughout the world. Due to increase in prices of petroleum the price of each and everything is increased & cause inflation. Causes of Inflation In Pakistan Increase in Indirect Taxation For increasing the revenue, the govt. impose indirect taxes. The increase in the indirect taxes raises the prices of goods and services causing inflation. Natural Calamities Natural calamities such as flood, Famines and earthquake also causes inflation by decreasing the supply of goods and tends the prices to go up. Psychological Factors As inflation continues, people fear more Sharpe rise in prices in the future. The consumer tries to buy today and seller to sell tomorrow and cause inflation. Social Evils Various social evils like black money or smuggling also causes inflation. Measures to Remove Inflation Monetary Measures Fiscal Measures Other Measures Monetary Measures Quantitative Control Qualitative Control Quantitative Control Interest Rate Policy Credit Rationing Change in Reserve Ratio Open Market Operations Quantitative Control Interest Rate Policy It means the rate of interest at which the commercial banks grant loans against first class securities according to the instructions of central bank. In case of inflation, the bank interest rate is raised which discourages borrowings, as a result credit contracts. On the other hand if there is deflation, the bank interest rate is lowered which encourages the borrowings as a result credit expand. Credit Rationing The central bank puts limit s for the grant of credit. The credit is rationed for each bank during financial crisis. If the central bank deposits expantionary monetary policy the rationing limit of loans increases. On the other hand if the central bank adopts the contractionary monetary policy the rationing limit of loans decreases. Quantitative Control Change In Reserve Ratio Every member bank is required to keep a certain amount of its total deposits as cash reserves with central bank. If there is more quantity of money in the country, the ratio is raised which reduces the credit base of banks and credit contracts. on the other hand, if there is less quantity of money then the ratio is reduced which increases the credit base of banks and credit expand. Open Market Operations It means purchase and sale of securities by central bank in open market. If there is more quantity of money, the central bank sells securities in market. Buyers make cash payments through commercial banks, so as a result credit contracts. On the other hand if central bank wants to increase the quantity of money in a country then he buys securities and makes payment in cash, as a result credit expands. Qualitative/Selective Control Direct Action Publicity Restriction on Advances Changes in Margins Qualitative/Selective Control Direct Action When the central bank realizes the fact that its policies regarding credit control are not being implemented then he takes following direct actions: Declares the scheduled banks as non scheduled banks and takes the facilities back Increases the ratio of cash reserve Refuses to re-discount the bills of exchange of scheduled banks Publicity Central bank keeps the nation well informed about economic conditions through news papers, radio and television etc. which enables the people to understand the economic condition of the country. Publicity throws a light on the following points: Policies of business concerns, their production and production targets Deposits of capital, quantity of loans, interest are of banks and level of inflation or deflation. Restriction on Advances In severe economic problems, the central bank may impose restrictions on commercial banks to grant loans. The central bank tries its level best to avoid this tool of credit control policy. Changes in Margins Margins means the difference between the amount of loan and the value of security. The minimum margin requirement on securities may be relaxed to encourage the borrowings and can be imposed to discourage the borrowing. Fiscal Measures Increase in taxation Reducing public sector borrowings Reducing Check on exports on indirect essential items taxation Fiscal measures Increase in taxation The increase in taxes means part of income of people will be transferred to govt. the purchasing power of general public will decrease. In this way inflation is controlled. Reducing public sector borrowings To control inflation govt. should reduce its borrowings from the public sector. Check on exports on essential items The surplus goods may be exported but the item , which are short at home market, should not be exported. The essential items cannot be exported in this way & inflation is controlled. Reducing indirect taxation To control inflation indirect taxes should be reduced. Other measures Control over wages and salaries Control over Imports Reducing Reduction in Population investments Foreign aids Control Controlling Devaluation Check Against hoarding And smuggling Other measures Control over wages & salaries: Govt should establish committees to maintain rate of wages and salaries. Unnecessary increase in wages leads to inflation. Reducing in foreign aids: Foreign aid increases the supply of money in the country so to control inflation there is a need to control foreign aid. Population control: Increase in population also leads to demand-pull inflation. So population control may be long term policy to control inflation. Other measures Control over imports: Gov. should take steps to control imports. This will help in maintaining balance of payments. Controlling devaluation: Gov. should control the rates of devaluation. Devaluation leads to increase in the prices of imports. Hence, inflation occurs. Check against hoarding and smuggling: The strict punishments should be given so that artificial shortage of commodities may be controlled to remove inflation.