Role of Inflation

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Role of Inflation and Change in Consumer Buying Power

THE ROLE OF INFLATION AND CHANGE INCONSUMER BUYING POWER

1 Institute of Business and Technology




INSTITUTE OF BUSINESS AND TECHNOLOGY

The Role of Inflation and Change inConsumer Buying Power

Prepared By

Iftikhar Hussain(BME-1209)

Muhammad Junaid(BME-1201)

Course Code : MKT-606

A project in partial fulfillment of the award of

MBA (Banking and Finance)

FACULTY OF MANAGEMENT SCIENCES

SPRING 2011









CONTENTS

Page No.

ACKNOWLEDGMENT………………………………………………….……03

ABSTRACT ……………………………………………………………………..04

CHAPTER NO.1 INTRODUCTION

1.1 Introduction…………………………………………………….07

1.2 Purpose of Study……………………………………………...08

1.3 Research Objectives………………………………………….08

1.4 Research Methodology……………………………………....09

CHAPTER NO.2 LITERATURE REVIEW

2.1 Literature Review…………………………………………….11

CHAPTER NO.3 INFLATION

3.1 Introduction...........................................................................16

3.2 Types of Inflation………………………………………………..17

3.3 Inflation in Pakistan …………………………………………….21

3.4 Impact of Inflation in Pakistan ...……………………………...27

CHAPTER NO.4 CAUSES OF INFLATION

4.1 Demand pull Inflation………………………………………….31

4.2 Cost push Inflation…………………………………………….32

4.3 Monetary policy……….....…………………………………….33

4.4 Political Instability……………………………………………...34

CHAPTER NO.5 INFLATION EFFECTS ON DIFFERENT SECTORS

5. I Production………………………………………………………37

5.2 Foreign Investment…………………………………………….37





5.3 Consumer Buying Power ……………………………………...38

5.4 Business…………………………….…………………………..38

5.5 Farmer …………………………………………………………..38

CHAPTER NO.6 CONTROLLING INFLATION

6.1 Monetary Policy Control Inflation………………………………40

6.2 Role of Central Bank and Government…………………….....40

CHAPTER NO.7 CONCLUSION AND RECOMMENDATIONS

7.1 Conclusion……………………………………………..……45

7.2 Recommendations……………………………………........46

REFERENCES………………………………………………………………...47





“Acknowledgement”

First of all we would thank Almighty ALLAH who has guided us the way for a

bright future. We would like to acknowledgement the help provided by our

teacher to make this project a success.

Our teacher Dr. Noor Ahmed Memon provided guidance and learning at every

step of the project which helped us, a lot in the questioning, data collection and

preparation of this report. We always gave full energy and showed willingness in

our project.

We are also thankful to our parents who accommodated us during those long

hours of work in writing Synopsis for Dissertation and all the friends and

colleagues who equally encouraged us.

We would also like to appreciate the co-operation. We got from my classmates at

the institute which boosted our morale and encouraged me to strive for better

results.

Iftikhar Hussain

(BME / 1209)

Muhammad Junaid

(BME/ 1201)





INSTITUTE OF BUSINESS AND

TECHNOLOGY

ABSTRACT SUBMITTED BY: Iftikhar Hussain

Junaid Pervaiz

DISCIPLINE: MBA (Banking and Finance)

TITLE OF PROJECT REPORT: Role of Inflation and Change in

Consumer Buying Power

MONTH OF SUBMISSION: May, 2011

NAME OF PROJECT SUPERVISOR: Dr. Noor Ahmed Memon

ABSTRACT

This paper tells us that the inflation will occur due to loose monetary policy

and mismanagement of supply of money. Monetary policy is also play a very

important role for controlling inflation. State bank (central bank) uses two policies

expansionary or concretionary. In expansionary policy state bank decreasenominal interest rate or increase supply of money this policy use for coming

foreign investment in the country. In concretionary state bank increase nominal

interest rate or decrease supply of money to control inflation. Political instability

also effects the inflation. If the political sector is stable in the country so inflation

will may be control because state bank will do supply of money in the market by





the manage way. Inflation also change the consumer buying power The

consumer buying power will depends upon the prices of goods and services. If

the prices of goods and services are not high so consumer purchasing power will

increase. Buying power will also depends on wages. If the consumer wages is

not increase only increase the price on commodities so buying power will be

fluctuate or decrease. . Inflation affect economy by redistributing income and

wealth and by impairing efficiency .Inflation usually favors debtors, profit seekers,

and risk taking speculators. It hurts creditors, fixed- income classes, and

investors.





CHAPTER # 1 INTRODUCTION

1.1 Introduction

1.2 Purpose of Study

1.3 Research Objectives

1.4 Research Methodology





1. INTRODUCTION

1.1 INTRODUCTION

Our cram will be paying attention at the diverse aspects of inflation in Pakistan

from a local and large-scale perspective. Pakistan has undergone a major

economic growth throughout previous few years. But the core evils of the

economy are still unsettled; Inflation remains the main of all these evils. In the

case of an Asian country, Pakistan inflation is the result of monetary phenomena.

The excess money supply increase in Pakistan has basically improved inflation.

Inflation is a get higher in the general level of prices of goods and services in an

economy over a period of time. When the general price level grows; each unit of

currency buys less goods/services. Inflation doesn’t single pressure the

macroeconomic indicators; it influences the living standards of the nation. As the

percentage of inflation enhance, the cost of all commodities also enhance. It can

also be described as a turn down in the real value of money—a thrashing of

purchasing power.

The level of inflation in Pakistan has been steadily rising since partition. The highlevels of inflation imitate an unstable economy in which money does not hold its

value for long. Workers require higher remuneration to cover rising costs, and are

disinclined to save. Manufacturer in turn may raise their selling prices to cover

these increases, scale back production to check their costs (resulting in lay-offs),

or fail to invest in future production. Many such problems have been, and still are,

being faced by Pakistan. The issues leading to high levels of inflation include

deficit financing, foreign remittances, foreign economic support, increase in

wages, population explosion, black money, prices of imported goods, devaluation

of rupee, etc.





1.2 Purpose of Study

The main purpose of this study is to know and learn about global essence of role

of inflation and its impact on Pakistan economy and more focused towards

inflation affect on different sector. In this study, we studied about the factors

causing inflation. It will be of great help to students of economics and business

studies. The study provides enough learning opportunities that one always looks

for, and such opportunities turn very healthy in terms with understanding the

subject which is under study.

1.3 Research Objectives

1. Present the set-up of inflation in Pakistan.

2. Underline the figures of recent years.

3. Impact of inflation on our society.

4. Cram the procedures that have been taken by government to supervise

inflation.

5. Evaluate policies of the State Bank of Pakistan and the tools it is using to

supervise inflation.

6. Give recommendations to control inflation.





1.4 Research Methodology

In this research, we contain data from primary and secondary sources. Data

used in this study are obtained from KSE 100, State bank of Pakistan, federal

bureau of statistic; stock price index etc…The information required for our

research consists of details about recent and past policies of State Bank of

Pakistan. Research instruments for this study included, interviews from

economists, columnists and other relevant people. The sources of information or

data on the Inflation collected through variety of ways in different setting. It also

contains fine points about other variables affecting inflation. For this, we aim to

gather secondary data, through websites, economic surveys and the journals.

However, if required, we can also use primary data in the forms of interviews andsurveys. Analysis of data would be done by carefully studying the collected data.

A concise explanation of the format of the results will be presented in the

following forms, e.g.

• Pie charts

• Line graphs

• Tables

Study Period/Division of Time for Project

Number of weeks Work done

Preparation, submission and acceptance of proposal 3 weeks

Data collection 5 weeks

Data analysis 4 weeks

Report preparation 4 week

The possible limitations in our research would be;

• Time constraint

• Knowledge constraint

• Data constraint





CHAPTER # 2 LITERATURE REVIEW





2.1 LITERATURE REVIEW

Inflation means rise of general level of price of goods and services in theeconomy over the period of time. Inflation occurs when the demand of goods will

be rising as compare to the supply of that good. If the supply is not equilibrium

(or less) to the demand of goods and services so the prices will be high. Inflation

will also occur when the cost of production will rice or increase price on raw

material so the manufacturer increase the finished good prices. Inflation impact

negative effect on economy because it decrease the real value of money.

Consumer buying power means how the people spend money on goods and

services or purchase the product on a specific availability of money or wages.

There are two factors that affect the consumer buying power. (1).Every person

wants to spend money for his basic needs or for his luxuries and entertainment

for example: (food, house, car, clothing, entertainment etc.). But the buying

power will change every year because of inflation. It will be happened because of

the product price will increase every year or you can say that decrease the value

of money. (2).Consumer buying power will also be change because of monthly

wages. If monthly wages is increase or the product or commodities price is same

then consumer go for extra activity but if the wages is not increase only increase

the product or commodities price so the effect is occur on consumer buying

power. They are only going for basic needs not for the luxuries etc.

ALEEM, KALIM (2007) Inflation is rise in Pakistan because of mismanagement

and loose control on monetary policy and fiscal policy. In monetary policy state

bank will issue the supply of money or if supply of money is not manage by state

bank efficiently so it’s affect on inflation or in fiscal policy government apply the

taxes on private sector. In 2005-06 inflation will be fluctuate because of loose

monetary policy. Now in Pakistan recent government apply expansionary policy.

In this policy government will increase the interest rate to control the inflation or

consumer buying power.





Rising oil prices in the market will also increase the price on food items or

commodities. Inflation in Pakistan wills also occur because of sharp increase in

net import. The gab between in domestic demand and domestic production is

filled import items. Comparison between import and export in Pakistan there is no

balance of trade or balance of payment. Rising trade deficit can be a cause of

expectation of high inflation.1

ABDUL (2007) this author tells us that monetary policy are playing very

important role for increasing inflation or how to control inflation. Monetary policy

successfully controls inflation when it successfully controls money supply in the

market. Monetary policy calculates the money supply with the help of M2 (cash

and checking account deposit + saving deposit and money market accounts).

But state bank of Pakistan is fail to control money supply last few years

that why inflation is rise in Pakistan. But now in Pakistan state bank will increase

the interest rate to control the inflation in Pakistan. Increasing the amount in

interest rate will affect demand for credit to the business sector and also affect

the money market rate. Increasing the amount in interest rate also affect the

demand on commodities.

FAROOQ (2008) this author tells us that political instability is effect the inflation.

Monetary policy will be effect because of political instability. If the political sector

is stable in Pakistan so inflation will may be control because state bank will do

supply of money in the market by the manage way.2

Political instability is a negative effect for the economy because of variable GDP

growth, private investment and inflation. Political stability is very important for the

economic development of a country. Political stability discourages speculation

and hoarding and encourages investment. If there is an unexpected twist in the

political situation of a country become entrepreneurs reluctant to invest. Just as

1 http://mpra.ub.uni-muenchen.de/16254/

2 http://mpra.ub.uni-muenchen.de/13056/ MPRA paper no. 13056, posted 29. January 2009.





foreign investors do not invest, while industrialists and businessmen feel

uncertain and can not make good plans. Due to the scarcity of goods and

services are produced and cause inflation

MOHSIN (2006) After forecast that why inflation is rise in Pakistan we examine

that because of variable monetary policy means variable money supply in the

market or given high credit to private sector not only this also charge the variable

interest rates. Every time state bank (central bank) was not made a good

monetary policy as well as they didn’t manage the supply of money in the market.

When ever the state bank decrease the interest rate so private sector will borrow

the loan from the bank or in this case private sector credit will be increase or

supply of money will also increase both growth’s are good leading indicator’s of

inflation.

Inflation will be control by using these four ways which are under below.

• Rise in the interest rates is a very useful tool for restricting monetary

inflation. Increase in the real rates of interest decreases the demand for

loans, thereby limiting the growth of broad money.

• There may also be a fall in the commercial investments, due to a rise in the

costs of borrowing money. This exerts a direct influence on a handful of

planned investment-related projects, which turn out to be unprofitable. This

leads to a fall in the collective demand.

• An increase in the payment of mortgage interests automatically decreases

the real 'effective' disposable income of the house owners, as well as their

spending capacities. Escalation in the mortgage costs also decreases the

demand generated in the housing markets.

3

ABDUL QAYYUM (2006) this author tells us the relation between excess money

supply growth and inflation. Excess money supply will be happened because of

3 http://ideas.repec.org/a/pid/journl/v45y2006i2p185-202.html







CHAPTER # 3 INFLATION

3.1 Introduction

3.2 Types of Inflation

3.3 Inflation in Pakistan

3.4 Impact of Inflation in Pakistan





3. INFLATION

3.1 Introduction

Inflation is a rise in the general level of prices of goods and services in an

economy over a period of time. When the general price level rise; each unit of

currency acquires less goods/services. Accordingly; inflation also reflects

abrasion in the purchasing power of money. An increase in the supply of money

relative to the availability of goods and services, resulting in higher prices and

decrease in the purchasing power.

There are many definitions of inflation. By inflation most people understand a

sustained and substantial rise in prices. For example:

W.A.L COULBORN’ words: “too much money chasing too few goods”.

Prof SAMUELSON, “Inflation occurs when the general level of prices and costs is

rising”.

According to ROWAN, “inflation is the process of price increase”





HARRY G JOHNSON, “We define inflation as substantial increase in prices”.

According to CROWTHER, “inflation as a state in which the value of money is

falling”.

According to MEYER, “An increase in the price that occurs after full employment

has been attained”.

According to KEYNES, “The rise in general price level after full employment had

been achieved is called inflation”.

3.2 Types of Inflation

Following are the types of inflation:

1. Creeping inflation.

2. Walking inflation or Mild inflation.

3. Running inflation.

4. Galloping or Hyper inflation.

5. Demands pull inflation.

6. Costs push inflation.

7. Mixed inflation or Wage spiral inflation.

8. Open inflation.

9. Suppresses inflation.

10.Profit induced inflation.

11.Budgetary inflation or Deficit inflation.

12.Monetary inflation.

13.Income inflation.

14.Production inflation.

15.Devolution inflation.

16.Imported inflation.

17.Ceiling inflation.





Creeping Inflation It is a situation where the increase in the price level is very

slow. In creeping inflation the rise in price level is up to 2 % p.a.

Walking Inflation or Mild Inflation When the rate of inflation is reasonable, not

too high not too low. The rise in price level is about 5 % p.a. This type of inflation

has healthy effect on economy.

Running Inflation In this type of inflation, the general price level increase more

sharply than the previous type. The rise in price is about 8 to 10% p.a.

Galloping or Hyper Inflation When prices are rising at abnormal high rate, it is

called hyper inflation. This type of inflation was experienced in Germany after

Second World War. The price level increase many hundreds time and the

purchasing power of people fell to very low level. This type of inflation is very

dangerous.

Demand Pull Inflation When inflation is due to excess of demand over

aggregate supply, it is called demand pull inflation. Excess of aggregate demand

pulls the price upwards. Aggregate demand exceeds aggregate supply due to

following reasons:

a) Population explosion.

b) Increase in exports.

c) Structural backwardness.

d) Increase in supply of money.

e) Increase in income of people.

f) Mass migration.

g) Wars.

Cost Push Inflation It means a condition where prices are growing due to raise

in the cost of production even if there is no increase in aggregate demand.





Increase in costs pushes the price in the air. Cost push inflation occurs due to

following reasons:

a) Increase in wages.

b) Increase the price of raw material.

c) New taxes.

d) Devaluation.

e) Increase in energy prices.

Mixed Inflation or Wage Spiral Inflation It is the mixtures of demand pull and

cost inflation. Originally prices rise due to excessive increase in aggregate

demand. Increase in raises the cost of living of the workers. In order to

compensate high cost of living, worker demand for high wage rates. Demands

for high wage rate are accepted during the period of rising prices. Increase in

wages will raise the cost of production. Therefore increase in wages will push

the price upward. Combined effect of wages and prices creates hyper inflation.

Open Inflation It is a situation when the inflation gets out of control and cannot

be controlled by government price control policy is called open inflation.

Suppressed Inflation It is the situation when the inflation can be controlled by

the government price control policy.

Profit Induced Inflation When businessmen tend to increase their profit and

increase the price of their commodities then their will be profit induced inflation. It

is usually occurs in such economy which are dominated by monopolies.

Monopolist is in the position to increase the price of his product at his will.

Budgetary Inflation or Deficit Inflation When the revenue of the government is

less than its expenditures, it is said to run budgetary deficit. To overcome this

deficit govt. makes borrowing from internal and external source to increase the





supply of money. Higher supply induced more consumption causing price level to

high.

Monetary Inflation When there is an expansion in the currency notes in

circulation then there will be monetary inflation.

Income Inflation The inflation which occurs from high income level is called

income inflation. In consumption oriented society where propensity to consume is

higher than propensity to save such higher income will induce people will induce

people to spend lavishly on consumer goods.

Production Inflation This inflation arises due to lack of capital projects. If the

process of industry is slow as compared to rare of growth of population, then

soon the economy would be unable to meet all the need s of its members.

Shortage of goods creates higher demand which forces the price to up.

Devaluation Inflation Devaluation makes our currency cheap in terms of foreign

currency. It also makes all those goods cheap whose prices are in rupees.

Further the exports of the country increases. Such increase in exports increases

the profit and income of local exporters. It leads to inflation.

Imported Inflation It means the inflation that arises due to increase in the price

of demand goods. Suppliers in foreign countries may increase the prices of their

products. This will affect the domestic consumers and producers. They will be

compelled to increase the price of goods. It will create inflation.

Ceiling Inflation that occurs due to various ceiling prices of government. Ceiling

prices are set by the government to maintain prices of essential goods. Price is

seized below the equilibrium to maintain prices of essential goods. Prices are

seized below the equilibrium price level of free market. However, the price ceiling

sometimes invites black marketing. It may cause inflation.









3.3 INFLATON IN PAKISTAN

Inflation during 2005-06

Inflation picked up to an average of 8.6% per annum during the last two years

(2004-05 and 2005-06) for a variety of reasons. First and foremost was the

extraordinary increase in international price of oil which more than doubled

during the last years; reaching an all time high of $78/bbl. The increase in

international oil prices, as a result contributed to the pick up in inflation during the

last years. Next issue has been the surge in demand; which put force on prices.Four years of well-built economic growth (on average, 7.0% per annum) gave

increase to the income levels of different segments of the society; which

supported domestic demand and put rising pressure on prices of necessary

commodities.

The government had taken numerous actions to bring inflation downward during

2005-06. These actions included the tightening of monetary policy as well as

enhancing the supply of necessary commodities through liberalizing of import

command. As a result the overall inflation registered a turn down from 9.3% in

2004-05 to 7.9 in 2005-06. Most importantly; food inflation declined from 12.4 to

6.9 during the same period. Non-food inflation on the other hand registered an

increase from 7.1 to 8.6%. In 2006, the development in non-government sector

borrowing was 23%. This development is reflected in the role of NGSB in

inflation; which was 35% in 2005-2006. One significant issue is import prices;

which explains 26.7% of the inflation in 2005-2006.

The government levies did not cause any major rise in prices in 2005-2006.

There was no additional strong force on import costs, because of a constant

exchange rate, such policy cannot be continued for long while trade shortfall set

the way.






In year 2006, core inflation from 7.1% in June 2006 came down to 5.5% in

December 2006; due to the tighter monetary position. The CPI-based inflation

during July-April 2006-2007 averaged 7.9% as against 8% in the same period

last year. The single biggest element of the CPI is the food group; which showed

an increase of 10.2%. This was higher than the 7% food inflation observed over

the corresponding period of last year. According to the State Bank of Pakistan,

the food inflation during the period increased because of supply side constraints.

On the other hand, the non-food prices grew at a slower pace compared to last

year. The non-food inflation averaged 6.2% between Julys-April 2006-07 while it

stood at 8.8% in the corresponding period of last year. The non-food non-energyinflation (core inflation) decelerated sharply to 6% in first ten months of the fiscal

year as against 7.7% in the same period last.

The tight monetary policy pursued by the SBP has resulted in the sharp reduction

in the core inflation. A more detailed analysis of the food group shows a

considerable variation in inflation rates of the items included in the group. For

example, considering the perishable and non-perishable items in the food group

separately shows that nonperishable food prices rose by 9.0% while the

perishable items prices grew by 17.6%. The estimated contributions to inflation

for perishable and non-perishable items are 11.5% and 40% respectively when

their weights are 5.14% and 35.2% respectively. Clearly, the contribution of

perishable items to inflation is nearly twice its weight. An analysis of individual

food items suggests that the major portion of food inflation during the current

year stemmed from a limited number of items including rice, edible oil, pulses,

meat, milk, tea, eggs, wheat, vegetables and fruits. These items have

experienced relatively larger increase in their prices during the course of 2006-

2007. However, prices of other important food items like sugar, potatoes,

tomatoes, Moong pulse and chicken (farm) have shown a decline in their prices

owing to improved availability of these items in the market.






Pakistan’s inflation in 2007 remained virtually unaffected from the 2006 rate,

standing at 7.8%. The inflationary trend in food prices persisted through most of

the fiscal year and was even higher, at 10.3% in 2007, affecting people living on

low and fixed incomes. The analysis suggests that the inflation was largely food

price driven. Prices of various types of pulses have increased this year because

of the short supply of these pulses in the country. Since milk powder and tea are

also importable items, the domestic prices were higher on the back of higher

international prices.

The inflation in 2007 was fuelled by worldwide increases in various goods prices,

higher utility tariffs and by local supply- and demand-driven issues. To include

food inflation; Pakistan’s government extended the public-sector utility-store

network, extending it even into rural areas. Throughout the network the

government provides large subsidies for the sale of necessary edibles. The

central bank reacted to high inflation by tightening monetary policy; it

concurrently raised the discount rate; the cash necessity on demand deposits

and the statutory liquidity requirement of demand and time deposits. In view of

the other CPI groups; the maximum inflation was in the Medicare group and

energy with reported 10 month inflation of 9.1% and 7.3% respectively. But since

their weights are small in the CPI basket (2.1% and 8.7%) their contribution to

inflation was small. On the other hand; house rent which has a 23.4% weight in

the CPI; showed a fall in inflation from 10.3% to 6.7%.






A delay in including more areas and in revising consumption patterns for

measurement of inflation has helped the government to cover up real inflationary

pressures in the economy, claimed Dawn. Before the start of the year; the

government had finished the family budget survey; launched in July 2007 for the

purpose of revising the base for measurement of inflation. The exercise was

delayed for years on the pretext of non-availability of funds. A senior official at

FBS said that the excuse of non-availability of funds for conducting survey to

revise the base year of CPI was unjust because the government had started a

number of other surveys and projects, reported Dawn.

Analysts say the government wanted to continue with the previous model

because it was based on a survey of urban areas only; ignoring rural consumers

who comprised 70% of the whole population. Furthermore; many objects covered

by the survey are either obsolete or their consumption has declined drastically

with the passage of time. The present average rate of inflation is around 25%

and if the base year is revised it will go up to over 30%.

This remarkably high trend is primarily a reason of high food inflation. Inflationduring 2008 point out that prices of a few (18) necessary food items registered

quick increase mainly during the second half of the fiscal year 2008. Other major

contributors to 2008's rising inflationary trend included house rent, which is the

index that measures the cost of production in Pakistan, racing to 11.35% by April

2008.


According to the Inflation Outlook covering the period of January-June 2009, the

inflation is expected to be in the range of 21.3 percent in the current month of

January 2009 as against 11.9% in January 2008. According to a Projection,

presented Economic condition committee of the Cabinet meeting held on

January 13, 2009 inflation was calculated at 24.3 percent at the start of July in





2007. According the reserve, the reason of Inflation is the continuation of year

2010. The Survey discovered that public was expecting that Inflation would

increase in future. It showed that demand-pull, cost push, structural issues were

responsible for current inflation in Pakistan and the government policies were not

useful to enhance growth.

In progress reason of inflation consist of demand, pull, cost push, structure

inflation. The survey discovered that cost-push issue was much responsible for

causing inflation. The contribution of cost push inflation was 29.1% followed by

demand-pull factor (14%), structure issues 13.5%. Collectively; all the three

issues were contributing about 56.1% to in progress inflation.


According to the assessments of analysts and researches; food

inflation is the main reason behind the speedy inflation. The CPI

inflation turned out higher than expectations as it rose by 13.23% on

yearly basis (2.51% on monthly basis) during the month of August 2010.

Food inflation, during August 2010 increased by 15.62% on yearly basis

(5.10% on monthly basis). Likewise, food inflationary impact contributed

as much as 91% of the total monthly basis CPI inflation. Items that

exceeded expectations included perishables such as vegetables as well

as ghee. This reinforces that existing inflationary pressure is due to

food inflation. The same provides support to the argument that an

upward revision in discount rate should not arise out of inflationary

concerns.

The government borrowings have also stayed within handy bound so

far, although it runs the risk of getting higher upon fiscal concerns

(deficit of 6.5% for FY11 is already projected).This only shows to be the

single most major issue in driving the interest rate direction for

FY11.CPI inflation has clocked in at 13.23% on yearly basis in August

2010; slightly high than the forecast of 12.85% yearly and against





12.34% yearly in July 2010. With a joint weight of 55% in the CPI basket,

food, energy, transport inflation rose by 15.62%, 21.29% and 14.27%,

respectively on yearly basis. The State Bank of Pakistan has recently

followed a policy of headline inflation targeting. In this regard; higher

than projected CPI in August 2010 and likely up tick above 15% on

yearly basis in Sep 2010 may guide to an upward force on the discount

rate going ahead; mainly if the SBP maintains its anticipatory position

and sidelines down trending core inflation.

Table: Annual Rate of Inflation (Percentage) in Pakistan for Period 2004-2011

Year Inflation rate (consumer prices) Rank Percent Change Date of Information

200

42.90 % 123 -25.64 % 2003 est.

200

54.80 % 143 65.52 % FY03/04 est.

2006

9.10 % 186 89.58 % 2005 est.

200

7

7.90 % 168 -13.19 % 2006 est.

200

87.60 % 162 -3.80 % 2007 est.

200

920.30 % 204 167.11 % 2008 est.

201

013.60 % 213 -33.00 % 2009 est.

2011

13.40 % 214 -1.47 % 2010 est.

Graph: Annual rate of Inflation in Pakistan for Period 2004 to 2011


0

5

10

15

20

25

years 2004 2005 2006 2007 2008 2009 2010 2011

years2004

2005

2006

2007

2008

2009

2010

2011




5

5 http://www.indexmundi.com/pakistan/inflation_rate_(consumer_prices).html





3.4 Impact of Inflation in Pakistan

In Pakistan, the mainly significant thing is the increase in prices of oil, gas, excise

duties and the raise in the utility tariffs. These all has an inflationary impact onthe economy. Pakistan with a population of about 16 million people has

undergone a considerable economic expansion during last few years; but the

center evils of the economy are still unclear. The government has also allowed

the import of different things through land routes from bordering countries. But all

these are less important actions. Evils like “inflation and poverty” can’t be

resolved by applying the secondary measures directly. These require strategic

planning, but unfortunately in Pakistan; these center evils have never undergone

such a planning method.

Government has not at all invited overseas investment for the production of

essential goods. Agriculture sector on which the main industries rely for the raw

material has not been given satisfactory subsidies. The main increase in the

prices is because of the rising prices of oil (as increased prices of oil enhance the

cost of production). But no such steps have been taken to manage the oil prices.

Domestic productions at less cost of production will not only make the availabilityof goods much easier but Aggregate Supply will also increase and domestic

industry will get developed. Inflation is one of the barriers on the way of growth.

In Pakistan, it has squeezed the main part of the population. It needs to be

controlled by considered planning. Domestic production should be encouraged

instead of imports, investment should be given first choice in consumer goods

instead of luxuries; Agriculture sector should be given subsidies, overseas

investment should be attracted and developed countries should be requested for

financial and managerial assistance. 6

6 http://qurratulain.wordpress.com/2006/10/29/inflation-in-pakistan/

http://www.pakistantimes.net/pt/detail.php?newsId=12410





Lastly a well-built monitoring method should be established on different levels in

order to have a sound evaluation of the process at every stage.

Inflation always damages ones' standard of living. Increasing prices mean people

have to pay more for the same goods and services. If income rises at a slower

rate as inflation; the standard of living turns down even if one makes more. So it

is the root cause in building and disturbing economy and people of the country

poor. If we desire to manage inflation we shall have to exact strict control over

the supply of money and evading any reduction to the supply of money. This is

the most suitable way, whereby we can control inflation efficiently and keep the

economy of the country in a well-built and established position.





Inflation remains the major of all these problems. In the case of an Asian

country, Pakistan inflation is the outcome of monetary phenomena. The surplus

money supply growth in Pakistan has basically enhanced inflation. Inflation is

one of the hindrances on the way of expansion. In Pakistan it has squeezed the

key part of the population. Inflation is one of the most dangerous elements which

have absorbed the Pakistan till now. As we are in the Globalization world the

Inflation is also increasing day by day in Pakistan. These are due to wrong

economical policy, wrong governance, immature political people who even don’t

know the meaning of Politics. And the world Economical decline has also hit a

Pakistan due to Inflation, Unemployment.





CHAPTER # 4 CAUSES OF INFLATION

4.1 Demand pulls Inflation

4.2 Cost push Inflation

4.3 Monetary policy

4.4 Political Instability





4. CAUSES OF INFLATION

4.1. Demand Pull-Inflation

Demand pull inflation fluctuate inflation when many individuals purchasing the

same goods. The price of commodities or goods will increase because of

imbalance in the aggregate supply and aggregate demand.

Aggregate demand means total amount of goods and services demanded in the

economy in a given time period. Aggregate demands will represented by this

formula which are under below:

Aggregate Demand (AD) = I + G + C + (X-M): I = Investment spending by

companies on capital goods. G = Government expenditures on publicly provided

goods and services. C = Consumers' expenditures on goods and services. X =

Exports of goods and services. M = Imports of goods and services. Aggregate

supply means total supply of goods and services produced with in the economy

in the given time period. Aggregate supply attributed number of variables or

changes in the size and Increase in wages, Increase in production cost, or

changes in inflation.7

The increase in8 money will

increase demand for goods and services from D0 to D1. If businesses cannot

significantly increase production and supply (S) remains constant. The

economy's equilibrium moves from point A to point B and prices will tend to rise,resulting in inflation.

7 http://www.tutor2u.net/themes/inflation/A2_Inflation_Notes/Main_Causes_of_Inflation.html

8 www.investopedia.com/terms/d/demandpullinflation.asp

tutor2u.net/economics/.../inflation/demand_pull_inflation.htm





4.2. Cost Push Inflation

Cost-push inflation occurs when businesses respond to rising production costs,

by raising prices in order to maintain their profit margins. Cost push inflationfluctuate inflation because of prices will increases due to increases in the cost of

wages and raw material. There is likely to be a forceful increase in the prices of

finished goods and services. Cost-push inflation, on the other hand, occurs when

prices of production process inputs increase. The sharp rise in the price of

imported oil in last two years will increase the prices of goods and services which

is a good example of cost push inflation.

Illustration Rising energy prices caused the cost of producing and transporting

goods to rise. Higher production costs led to a decrease in aggregate supply

(from S0 to S1) and an increase in the overall price level because the equilibrium

point moved from point Z to point Y.

There are many reasons why costs might rise:





Rising imported raw materials costs: perhaps caused by inflation in countries

that are heavily dependent on exports of these commodities or alternatively by a

fall in the value of the pound/dollar in the foreign exchange markets which

increases the UK/USA price of imported inputs.

Higher indirect taxes imposed by the government: for example a rise in the

rate of excise duty on alcohol and cigarettes, an increase in fuel duties or

perhaps a rise in the standard rate of Value Added Tax or an extension to the

range of products to which VAT is applied. These taxes are levied on producers

(suppliers) who, depending on the price elasticity of demand and supply for their

products, can opt to pass on the burden of the tax onto consumers. For example,

if the government was to choose to levy a new tax on aviation fuel, then thiswould contribute to a rise in cost-push inflation.

4.3. Monetary Policy

Inflation is rise because of mismanagement and loose control on monetary

policy. In monetary policy state bank will issue the supply of money or if supply of

money is not manage by state bank efficiently so inflation will be affected. We

examine that because of variable monetary policy means variable money supplyin the market or given high credit to private sector not only this also charge the

variable interest rates. Whenever state bank (central bank) will not manage the

supply of money in the market efficiently then the inflation will be increase.

Types of Monetary Policy : There are two types of monetary policy which are:

1. Expansionary Policy In this policy state bank(central bank) will decrease the

nominal interest rate or increase the supply of money so the private 9sector will

borrowing the loan from the bank at very low interest rate. This policy is use to

came foreign investment in the country.

9 www.investopedia.com/terms/m/monetarypolicy.asp





1. Contractionary policy In this policy state bank (central bank) will

increase the nominal interest rate or decrease the supply of money in the

market for controlling the inflation rate in the country.10

4.4. Political Instability

Political instability also fluctuate the inflation in any country. Monetary policy will

be effect because of political instability. If the political sector is stable in Pakistan

so inflation will may be control because state bank will do supply of money in the

market by the manage way.

Political instability is a negative effect for the economy because of variable GDP







services are produced and cause inflation.

10 http://useconomy.about.com/od/glossary/g/Contractionary.html





CHAPTER # 5 INFLATION EFFECTS ON DIFFERENT

SECTORS

5. I Production

5.2 Foreign Investment

5.3 Consumer Buying Power

5.4 Business

5.5 Farmers





5. INFLATION EFFECTS ON DIFFERENT SECTORS

Inflation hurts your standard of living because you have to pay more and more for

the same goods and services. If your income doesn't increase at the same rate

as inflation, you will find your standard of living declining even though you are

making more. Also, inflation doesn't impact everything equally, so that some

things (such as gas prices) can double while other things (your home) may lose

value. For this reason, it makes financial planning more difficult. Inflation is really

bad for your retirement planning because your target will have to keep getting

higher and higher to pay for the same quality of life. In other words, your savings

will buy less and less, so you will need to save more and more. Inflation and the

economy both influence all the major macroeconomic indicators of a country. The

various macroeconomic indicators include the following:

• Gross domestic product or GDP

• Producer price index (industrial)

•

Consumer price indices• Industrial production

• Capital Investment

• Agricultural production

• Export

• Import

• Demography

• Debt

Inflation not only affects the macroeconomic indicators, it affects the living

standards of the people. As the percentage of inflation increases, the cost of

all commodities also increases. This in turn influences trade. When exchange

rates are affected, the interest rates cannot be far behind.





P AKISTAN GDP G ROWTH RATE Pakistan Gross Domestic Product (GDP) expanded

2.00% over the last 4 quarters. The Pakistan Gross Domestic Product is worth

168 billion dollars or 0.27% of the world economy, according to the World Bank.

Pakistan's economy has suffered in the past from decades of internal political

disputes, a fast growing population, mixed levels of foreign investment, and a

costly, ongoing confrontation with neighboring India. However, IMF-approved

government policies, bolstered by foreign investment and renewed access to

global markets, have generated solid macroeconomic recovery during the last

decade.

Pakistan GDP Growth Rate chart, historical data

5.1. Production

i) Reduction in Production: Inflation will affect on production due to

increase in the cost of raw material and increasing will increase the prices on

commodities.

ii) Fall in Quality: Continuous rise in prices producer produce and sell

sub-standard commodities in order to earn higher profit margin. They also

indulge in adulteration of commodities.11

5.2. Foreign Investment

Inflation will affect the foreign investment because prices increase on row

material or in the commodities make foreign investment less profitability.

11 http://www.excellentguru.com/index.php?option=com_content&view=article&id=78:effects-of-

inflation&catid=42:economics&Itemid=59





5.3. Consumer Buying Power

Inflation hit wages earner and salaries people because if the prices of goods

and services will rising and not rising his wages or salaries so these type of

people are highly affected during inflation. And purchasing power of these people

is also decrease.

5.4. Business

Inflation is welcome by entrepreneurs and businessmen because they stand to

profit by rising prices. They find that the value of their inventories and stock of

goods is rising in money terms. They also find that prices are rising faster than

the costs of production, so that their profit margin is greatly enhanced. The

business community, therefore, gets supernormal profit during periods of

inflation, and those profits continue to increase as long as prices rise.

5.5. Farmers

Farmers are benefit during inflation because of two factors.

a) Increase in the cost of production and the rise in the prices

b) The prices of farm products increase. Those farmers produce highly inflation

sensitive products are benefited the most.

Farmer will take benefits due to increase in inflation. Because the product which

the produce due to inflation the prices on that product will increase. It willshappen with those farmer who produce highly inflation sensitive products. 12

12 http://www.excellentguru.com/index.php?option=com_content&view=article&id=78:effects-of-

inflation&catid=42:economics&Itemid=59





CHAPTER # 6 CONTROLLING INFLATION

Monetary Policy Control Inflation

Role of Central Bank and Government





6. CONTROLLING INFLATION

6.1 Monetary Policy Control Inflation

Monetary policy can control the inflation if the state bank (central bank) can use

the concretionary policy. In this policy state bank increase the interest rate or

decrease the supply of money in the market. Then the aggregate demand of

goods and services will also decrease because the borrower not borrowing the

loan on very high interest rate.

A rise in real interest rate should reduce the demand for lending and therefore

reduce the growth of broad money. Monetary policy can be used to control

inflation. Inflation is defined as continuing increases in price levels. Since price

level is a monetary variable, monetary policy can affect it. Contractionary

monetary policy has the effect of reducing inflation by reducing upward pressure

on price levels.13

6.2 Role of Central Bank and Government

New democratic Government has entered with serious projection of the last

year’s macroeconomic differences in the economy. At the same time it carries

the duty of satisfying the targets and guarantees to the nation. The trade offs are

not easy and worldwide economic surroundings continues to be fraught with

doubts though some trends are reasonably clear; worldwide growth has slowed

downward; international liquidity grip persists, Pakistan self-governing rating

prevents beating international markets and international commodity prices stay

high. SBP chief explained in detail how a lot subsidized commodity prices including

that of petroleum products, power and gas has resulted in weighty government

borrowing from the central bank; which therefore had a negative impact on

13 http://www.economywatch.com/inflation/controlling.html


http://en.wikipedia.org/wiki/Inflation

http://en.wikipedia.org/wiki/Inflation




inflation. He also talked about borrowings of the public sector enterprises; which

partly give details shift of subsidies from the government’s budgetary

expenditures straight to the power sector entities; which rise by 305% during

June 2007 and October 2010 contrast to only 17% during 2003 and June 2007.

The contribution of this towards increase in money and so overall inflation should

not be discounted; he said, and explained that even if the food and energy group

prices were excluded from CPI; there was extensive increase in inflationary

stress. Both non-food-non-energy (NFNE) and trimmed measures of core

inflation certify this examination.14

In cooperation the Government and central bank have taken a put of fiscal

and monetary policy measures over the term of FY08 to control macroeconomicdifferences. While other countries have larger room to maintain growth at the

cost of higher inflation; the trade off for Pakistan would not be reasonable while

inflation is already very high, while growth is still at a good level. The

Government has taken different steps to free demand pressures on the one hand

and increase supplies of fundamental commodities on the other.

The Government has its policy plan to assurance high development; while

custody inflation in test out. Development create more jobs and raises incomes;

straight contributing in falling poverty.

In order to ease demand pressures; the State Bank of Pakistan (SBP) has

constantly tightened the monetary policy over the previous few years and more

so in the existing fiscal year. Budget shortfall for FY09 has been rolled back to

4.7 percent of GDP by the government to accomplish net zero borrowing from

SBP during the course of the year; while enhancing its trust on other non bank

sources. To increase supplies, the Government has comfortable its import

command and permitted imports of numerous vital items so, that there is a

nonstop flow in the supply of those significant commodities. The government also

improved the scale of operations of the Utility Stores Corporation (USC) which

14 http://www.dailytimes.com.pk/default.asp?page=2010%5C12%5C14%5Cstory_14-12-2010_pg5_1





supplies necessary commodities, such as wheat flour, sugar, pulses, cooking oil/

ghee at a smaller amount than the market prices. The maintain price for wheat

has been increased with a view of providing the true price to Pakistani farmers;

encouraging them to produce more wheat. Moreover, a superior bear price of

wheat will also help in disappointing smuggling and will make sure sufficient

supplies of this commodity in the country. In view of the risk linked to increasing

outside existing account and fiscal deficits and decline inflation outlook; the SBP

has determined to increase its policy rate by 100 bps to 13 percent to include

added aggregate demand pressures which are contributing to the inflationary

forces.15

Methods of Issuing Currency Issuing currency is one of the core functions of central bank. The power entrusted to it yields the following advantages.

1. Money supply is in complete grip of the bank

2. The currency system becomes uniform.

3. The system enjoys complete confidence of the public which is

necessary for the success of any currency.

A currency can be issued under the following systems.

Minimum Reserve System Under it a certain level of gold reserve is fixed

against which any amount of currency can be issued.

Advantages It facilitate saving of gold’s, It is flexible and allows to expand and

contract money supply to the need.

Limitation The system is exceedingly prone to inflation leading to the collapse of

currency; it may lose public confidence for over-issue of currency.

15 http://www.sbp.org.pk/m_policy/2011/MPD-Mar-11(Eng).PDFEconomics in plan English





Fixed Reserve System C urrency is issued up to a certain amount without any

reserve of gold, but against government securities. However, when currency is

needed more than the fixed level it must be backed by gold penny for penny.

Merits It is safe system, Inflation is well controlled, It enjoys public confidence to

the highest.

DEMERITS The system is inelastic, It adversely affect industrial growth, It lacks

frugality, because it requires much gold, It is a costly system.

Proportional Reserve System This system calls for a proportionate gold and

silver reserve to the total issue of currency. It allows increase or decrease of the

ratio as the accepted currency-issuing system.

Advantages It is flexible, It is helpful in industrial growth, Gold and silver are

required in comparatively small amount.

Disadvantages Inflation to some extent is possible, Keynes declared it an

extravagant and wasteful system, Government have tendency to violate and

deviate from the proportionate reserve requirement.

Simple Deposit System This system necessitates a hundred percent gold

reserve for the issue of currency.

Pros This system enjoys the following advantages. It is absolutely safe, Inflation

is not possible.

CONS It suffers the following disadvantages. It is inelastic and cannot be

changed to the requirement, It restricted business and industrial growth, A largeamount of gold and silver is needed and as such the system is costly and

wasteful, it faces the risk of deflation, It is impractical.16

16 Modern Banking(Mohammad amin khalid)





CHAPTER # 7 CONCLUSION AND RECOMMENDATION

7.1 Conclusion

7.2 Recommendations





7. CONCLUSION AND RECOMMENDATION

7.1 CONCLUSION

Inflation will be occur or increase due to Aggregate demand and Aggregate

supply. Aggregate demand means demand of goods and commodities is high

and the supply of goods and commodities is decrease.

Inflation will also fluctuate due to increase the prices in the raw material.

Whenever the prices are rice on raw material so the production cost of goods

and commodities will be increase.

Inflation will also occur because of mismanagement and loose control on

monetary policy. In monetary policy state bank will issue the supply of money or

if supply of money is not manage by state bank efficiently so inflation will be

fluctuate.

Increasing Inflation is highly effected on social sector and economy of the country

Inflation will increase the unemployment in country because the private sector is

downsizing the employees to minimize the expenses of the industry or company.

Inflation also affects the wealth of people and purchasing power of consumer

because if the prices will increase on goods and services and not increase the

wages of the people so the purchasing power is decrease. Inflation will also stop

the foreign investment in the country. Inflation also effects the production,

consumer buying power, business community and farmers.

Political instability also fluctuate the inflation in any country. Monetary policy will

be effect because of political instability. If the political sector is stable in Pakistan

so inflation will may be control because state bank will do supply of money in the

market by the manage way.Political instability is a negative effect for the economy because of variable GDP











services are produced and cause inflation.

7.2 RECOMMENDATIONS

Inflation will be control when the state bank is managing the supply of money in

the market. When we talk about in Pakistan inflation will be occur because of

variable money supply in the market or giving higher credit to private sector on

variable interest rate.

Inflation will also be decrease if the government decreases the taxes such as

sales tax and excise duty raise the prices of consumer goods.

Inflation will also be decrease if government manage or export the GDP products

to other country when the GDP product is in surplus or after fulfill the people

needs of that country.

Government should also manage the Aggregate demand and Aggregate supply

of goods and services for decreasing the inflation.

Government should also minimize his expenses and control the corruption in thecountry to control the inflation.

Now a days inflation is highly increase due to increase the prices on raw material

and oil prices but no such steps have been taken to control the oil prices.

To control inflation state bank should apply the contractionary policy. In this

policy state bank decrease the supply of money or increase the interest rate.

Government should giving subsidies to Agricultural sector for control inflation on

goods.





REFERENCES

• Khan, Abdul Aleem, Ahmed, Qazi Masood and Hyder,

Kalim (2007):“Determinants of Recent Inflation in Pakistan”. The Pakistan

Development Review site http://mpra.ub.uni-muenchen.de/16254/ MPRA

Paper No. 16254, posted 14. July, 2009/12:32.

• Qayyum, Abdul (2008): “Does Monetary Policy Play Effective Role in

Controlling Inflation in Pakistan” the Pakistan development review site

http://mpra.ub.uni-muenchen.de/13080/ MPRA Paper No. 13080, posted

Jan, 2009.

• Khan, Safdar Ullah and Saqib, Omar Farooq (2008): “Political Instability

and Inflation in Pakistan”. The Pakistan development review sitehttp://mpra.ub.uni-muenchen.de/13056/ MPRA paper no. 13056, posted

29. January 2009.

• Mohsin S. Khan and Axel Schimmelpfennig; September 2006 “Inflation in

Pakistan”. The Pakistan development 185-202,site:

http://ideas.repec.org/a/pid/journl/v45y2006i2p185-202.html

• Abdul Qayyum, 2006 “Money, Inflation and Growth in Pakistan”. The

Pakistan development review pages 203-212 site,

http://ideas.repec.org/p/pra/mprapa/2055.html

• http://qurratulain.wordpress.com/2006/10/29/inflation-in-pakistan/

• http://www.economywatch.com/inflation/economy/

• http://www.mba-tutorials.com/economics/638-reasons-of-inflation.html

• http://www.docstoc.com/docs/8717995/Inflation-trends-in-Pakistan-and-

the-factors-affecting-it

• http://www.pakistantimes.net/pt/detail.php?newsId=12410

• http://www.articlesbase.com/business-articles/inflation-in-economy-

881789.html

• http://www.mbaknol.com/managerial-economics/causes-and-effects-of-

inflation/

• http://uk.ask.com/wiki/Contractionary_monetary_policy





• http://www.answers.com/topic/aggregate-demand

• http://www.infocheese.com/costpushinflation.html

• http://www.defence.pk/forums/economy-development/3517-identifying-

causes-high-inflation.html

• http://www.blurtit.com/q7640820.html

• http://www.economywatch.com/inflation/controlling.html

• http://www.frbsf.org/education/activities/drecon/2002/0210.html

• http://www.unescap.org/survey2008/notes/pakistan.asp

• http://www.tutor2u.net/themes/inflation/A2_Inflation_Notes/Main_Causes_

of_Inflation.htm

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http://wiki.answers.com/Q/What_causes_inflation_not_what_is_inflation• http://tutor2u.net/economics/revision-notes/a2-macro-causes-of-

inflation.html

• http://www.frbsf.org/education/activities/drecon/2002/0210.html

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• http://www.economywatch.com/inflation/controlling.html

• http://www.indexmundi.com/pakistan/inflation_rate_(consumer_prices).ht

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Role of Inflation

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