INFLATION

PRESENTED BY-

M.ASSAD FAHIM KHAN

MBA-1

CONTENTS

glimpse of what is to come

Definition & Origin

Types of Inflation

Causes of Inflation

Effect of Inflation

Measuring of Inflation

Controlling of Inflation

“ Inflation is when you pay fifteen dollars for the Ten dollars haircut you used to get for five dollars, when you had hair ”

INFLATION

What is inflation

Layman Rise in Price

Technical Speaking

It is a rise in the general level of prices of goods and services imbalance between the quantity of money and trade needs

That IS……………

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ORIGIN• The term “Inflation” originated as devaluation of currency and not rise in price of as we now know it.

• In times when gold was used as currency, the government or the King used dilution as a measure to raise the profits through Seigniorage.

• This practiced increased the money supply but at the same time lowered the relative value of each coin. Due to this , more coins were needed for the same goods & services.

Types of Inflation

There are many types of Inflation as described by the Economist but three important types are:

• Creeping Inflation

• Running Inflation

• Hyper Inflation

1) Creeping Inflation

“When the rise in prices is very low like that of a snail or creeper, is called Creeping Inflation”.

It is the mildest form of inflation and also known as a Mild Inflation or Low Inflation.

The general level of prices rise at a moderate rate over a long period of time.

According to R.P. Kent, when prices rise by not more than (up to) 3% per annum (year), it is called Creeping Inflation

2) Running Inflation

A rapid acceleration in the rate of rising prices is referred as Running Inflation.

When prices rise by more than 10% per annum, running inflation occurs.

Economists have not suggested a fixed range for measuring running inflation, we may consider price rise between 10% to 20% per annum (double digit inflation rate) as a running inflation.

Persistent running inflation reduces the savings in the economy and results in slowdown in economic growth.

2) Hyper Inflation

Prices rise very fast at double or triple digit rate.

In quantitative terms, when prices rise above 1000% per annum

Also called Runway or Galloping Inflations.

The prices rise so fast that it becomes very difficult to measure its magnitude.

Many Latin American countries like Argentina and Brazil had inflation rates of 50 to 700 percent per year in the 1970s and 1980s.

Many developed and industrialized countries like Italy and Japan also witnessed the hyper inflation in the past. 

Causes of Inflation

Inflation is caused due to several economic factors:

When the government of a country print money in excess, prices increase to keep up with the increase in currency, leading to inflation.

Increase in production and labor costs, have a direct impact on the price of the final product, resulting in inflation.

There are two main causes for inflation which is stated as below:

Demand Pull Cost Push

1) Demand Pull

This type of inflation happens when the aggregate demand increases more than the supply

Demands pull inflation, where in the economy demands more goods and services than what is produced.

Demand Pull Inflation in AD-AS Graph

The reasons for the shift in AD curve can be either real or monetary factors. It is due to:

The real factorsThe monetary factors

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Real Factors: The real factors can be increase or decrease in the tax receipts

and corresponding increase or decrease in government expenditure. Other factors are investment function, consumption function and export function.

The monetary Factors:

Monetary factors can be increase or decrease in the money supply.

Example:

In 1990s when Russian government financed its budget deficit by printing rubbles, the inflation rate per month increased to 25 percent per month and the annual inflation rate was 1355 percent.

2) Cost Push

When prices rise due to growing cost of production of goods and services, it is known as Cost-Push (Supply-side) Inflation.

For e.g. If wages of workers are raised thenthe unit cost of production also increases. As a result, the prices of end-products or end-services being produced and supplied are consequently hiked.

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Quantity

POSITIVE EFFECT

NEGATIVE EFFECT

Effect on Economy

Positive EffectProbably the most significant effect of inflation is its effect on the revenues of the government. When inflation is higher than previously thought and planned with, the revenues of the government increases, which is good as the budget balance of the government improves. The reason why revenues of the government increases when inflation increases is because the government has higher tax revenues. For example a company sells its products and services at higher prices, which increases the total income of the company, which in turn increases the gross (before tax) profits of the company (provided that all other factors influencing profits remain constant). Greater before tax profits result in greater taxes paid to the government.

Negative Effect• Uncertainty about future inflation may discourage investment and saving.• Where fixed exchange rates are imposed, higher inflation than in trading partners' economies will make exports more expensive and tend toward a weakening balance of trade.• Menu costs: Firms must change their prices more frequently, which imposes costs, for example with restaurants having to reprint menus.

Measuring of Inflation

Measured Inflation

To illustrate the method of calculation, in January 2007, the U.S. Consumer Price Index was 202.416, and in January 2008 it was 211.080. The formula for calculating the annual percentage rate inflation in the CPI over the course of 2007 is

The resulting inflation rate for the CPI in this one year period is 4.28%, meaning the general level of prices for typical U.S. consumers rose by approximately four percent in 2007.

211.080 – 202.416 -------------------------- 100 % 202.416

Controlling of Inflation Effective policies to control inflation need to focus on the underlying

causes of inflation in the economy.

Monetary Policy

Monetary policy can control the growth of demand through an increase in interest rates and a contraction in the real money supply. For example, in the late 1980s, interest rates went up to 15% because of the excessive growth in the economy and contributed to the recession of the early 1990s.

Monetary measures of controlling the inflation can be either quantitative or qualitative. Bank rate policy, open market operations and variable reserve ratio are the quantitative measures of credit control, by which inflation can be brought down. Qualitative control measures involve selective credit control measures.

 

Bank rate policy is used as the main instrument of monetary control during the period of inflation. When the central bank raises the bank rate, it is said to have adopted a dear money policy. The increase in bank rate increases the cost of borrowing which reduces commercial banks borrowing from the central bank. Consequently, the flow of money from the commercial banks to the public gets reduced. Therefore, inflation is controlled to the extent it is caused by the bank credit. 

Cash Reserve Ratio (CRR) : To control inflation, the central bank raises the CRR which reduces the lending capacity of the commercial banks. Consequently, flow of money from commercial banks to public decreases. In the process, it halts the rise in prices to the extent it is caused by banks credits to the public. Open Market Operations: Open market operations refer to sale and purchase of government securities and bonds by the central bank. To control inflation, central bank sells the government securities to the public through the banks. This results in transfer of a part of bank deposits to central bank account and reduces credit creation capacity of the commercial banks.

Fiscal Policy:

It Majorly pertains to taxation and interest policies .

• REDUCTION IN UNNECESSARY EXPENDITURE • INCREASE IN TAX • INCREASE IN SAVING• SURPLUS BUDGET • PUBLIC DEBT

Lack of balance in the country’s budget. Financial problem, financing the deficit of

money by printing. Sudden increase in production costs. Significant increase in the level of energy

resources. Faulty structure of the economy . Exported goods far exceeding imported

ones. Too many monopolies in the economy. Imported Inflation . Problems with financial planning.

Reason of Inflation in Pakistan

CONCLUSION…

From various monetary , fiscal and other measures it becomes clear that to control inflation government should adopt all measures simultaneously.

Inflation is like a hydra-headed monster which should be fought by using all the weapons at the command of the government.

Thank U !