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Browse: Home / Inflation and its impact on the Pakistan economy
Pak Economy: Rethinking economic policies to take-off Reasons for growing unemployment in Pakistan

Inflation and its impact on the Pakistan economy

Pak Economy Add comments
Jun 162009
Changes in the exchange rate and the prices of goods and services
By Parveen Zaiby
Inflation is the rise in the prices of goods and services in an economy over a period of time. When the
general price level rises, each unit of the functional currency buys fewer goods and services; consequently,
inflation is a decline in the real value of money — a loss of purchasing power in the internal medium of
exchange, which is also the monetary unit of account in an economy. Inflation is a key indicator of a country
and provides important insight on the state of the economy and the sound macroeconomic policies that
govern it. A stable inflation not only gives a nurturing environment for economic growth, but also uplifts the
poor and fixed income citizens who are the most vulnerable in society.

Causes of inflation

It has been generally agreed by the economists that high rates of inflation and hyperinflation are caused by
an excessive growth in the supply of money. Today, most economists favour a low steady rate of inflation.
Low (as opposed to zero or negative) inflation may reduce the severity of economic recessions by enabling
the labor market to adjust more quickly in a downturn, and reduce the risk that a liquidity trap prevents
monetary policy from stabilising the economy. The task of keeping the rate of inflation low and stable is
usually given to monetary authorities. Generally, these monetary authorities are the central banks that
control the size of the money supply through the setting of interest rates, through open market operations,
and through the setting of banking reserve requirements.

There are many causes for inflation, depending on a number of factors. For example, inflation can happen
when governments print an excess of money to deal with a crisis. When any extra money is created, it will
increase some societal group’s buying power. As a result, prices end up rising at an extremely high speed to
keep up with the currency surplus. All sectors in the economy try to buy more than the economy can
produce. Shortages are then created and merchants lose business. To compensate, some merchants raise
their prices. Others don’t offer discounts or sales. In the end, the price level rises. This is called demand-pull
inflation, in which prices are forced upwards because of a high demand, and excessive monetary growth.
For inflation to continue, the money supply must grow faster than the real GDP.

Another common reason of inflation is a rise in production costs, which leads to an increase in the price of
the final product. For example, if raw materials increase in price, this leads to the cost of production
increasing, this in turn leads to the company increasing prices to maintain their profits, this kind of inflation is
call cost-push inflation. Furthermore, rising labour costs can also lead to inflation, because workers demand
wage increases, and companies usually chose to pass on those costs to their customers, this sort of inflation
is called wage-push inflation.

Inflation can also be caused by international lending and national debts. As nations borrow money, they
have to deal with interests, which in the end cause prices to rise as a way of keeping up with their debts. A
deep drop of the exchange rate can also result in inflation, as governments will have to deal with differences
in the import/export level.
Finally, inflation can also be caused by federal taxes put on consumer products. As the taxes rise, suppliers
often pass on the burden to the consumer; the catch, however, is that once prices have increased, they
rarely go back, even if the taxes are later reduced.

Effects and measurement of inflation

The most immediate effects of inflation are the decreased purchasing power of the rupee and its
depreciation. Depreciation is especially hard on retired people with fixed incomes, as spending power
decreases each month. Those not on fixed incomes are more able to cope, because they can simply
increase their income. Another destabilising effect of inflation is that some people choose to speculate
heavily in an attempt to take advantage of the higher price level. Because some of the purchases are high-
risk investments, spending is diverted from the normal channels and some structural unemployment may
take place. Finally, inflation alters the distribution of income. Lenders are generally hurt more than borrowers
during long inflationary periods, which mean that loans made earlier are repaid later in inflated rupees.
Inflation weakens the function of money as storage of value, because each unit of money is worth less with
the passing of time. The progressive loss of the value of money during a period of inflation makes the
borrowers to be less willing to use the money as standard differed payments.

To measure the price level, economists select a variety of goods and construct a price index such as the
consumer price index (CPI). This is one measure of inflation. The CPI measures inflation as experienced by
consumers in their day-to-day living expenses; it is the ratio of the value of a basket of goods in the current
year to the value of that same basket of goods in an earlier year. By using the CPI, the inflation rate can be
calculated. This is done by dividing the CPI by the beginning price level and then multiplying the result by
100. The GDP deflator is another very important measure of inflation as it measures the price changes in
goods that are produced domestically.

Pakistan publishes four different price indices, namely: the consumer price index (CPI), the wholesale price
index (WPI), the sensitive price index (SPI) and the GDP deflator. The CPI is the main measure of price
changes at the retail level. It indicates the cost of purchasing a representative fixed basket of goods and
services consumed by private households. In Pakistan, the CPI covers the retail prices of 374 items in 35
major cities and reflects roughly the changes in the cost of living of urban areas. The WPI is designed for
those items which are mostly consumable in daily life on the primary and secondary level; these prices are
collected from wholesale markets as well as from mills at organised wholesale market level. It covers the
wholesale price of 106 commodities prevailing in 18 major cities of Pakistan. The SPI shows the weekly
change of price of 53 selected items of daily use consumed by those households whose monthly income in
the base year 2000-01 ranged from Rs3000 to above Rs12000 per month. The SPI also informs about the
actual position of supply: whether the commodity is available in market or not. If the commodity is not
available, the reason for that is also recorded. It is based on the prices prevailing in 17 major cities and is
computed for the basket of commodities being consumed by the households belonging to all income groups
combined as in CPI. In most countries, the main focus for assessing inflationary trends is placed on the CPI,
because it most closely represents the cost of living. In Pakistan, the main focus is also placed on the CPI
as a measure of inflation as it is more representative with a wider coverage of 374 items in 71 markets of 35
cities around the country. Inflation has started veering its ugly head in many parts of the world, including
Pakistan. Food inflation has emerged as the main contributor to inflationary pressures. (See Table)

The inflation rates based on CPI, SPI and WPI for the year 2008-09 increased by 22.35 per cent, 26.33 per
cent and 21.44 per cent respectively over the corresponding period of 2007-08. It increased by 10.27 per
cent, 14.09 per cent and 13.70 per cent respectively in 2007-08 over the corresponding period of 2006-07.
In 2006-07, the rate of inflation increased by 7.89 per cent, 11.13 per cent and 6.92 per cent respectively
over the same period of 2005-06. An analysis of data for last three years for the same period indicates that
CPI, SPI & WPI were higher as compared to last two years. (See Chart)

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.

ALL THREE INDICES CPI, SPI AND WPI AT A GLANCE

Average July–April over same period of previous year

(Change of indices in %)

Index 2006-07 2007-08 2008-09

CPI 7.89 10.27 22.35

SPI 11.13 14.09 26.33

WPI 6.92 13.70 21.44

Source: FBS

http://www.thenews.com.pk/

Related Posts:
• Pak Economy: Fiscal Policy Choices in Budget 2008-09 – II
• Pak Economy: Inflation surpasses government’s target
• Pakistani inflation seen at 11% for FY ’09-10
• Pak Economy: Inflation highest in thirty years
• The plight of Pakistan economy
Posted by Raheem at 4:56 pm

14 Responses to “Inflation and its impact on the Pakistan economy”

1.

ahmed says:
March 22, 2010 at 3:51 pm

IT IS VERY WELL WRITTEN.

 2.

MAZEN says:
April 17, 2010 at 3:03 pm

its gud but there should be more causes written,as these are very common known by the people.

3.

mobari says:
May 16, 2010 at 10:04 pm

Any idea as to how much the infamous IMF has contributed to the inflation situation in Pakistan.

4.

shakir says:
November 6, 2010 at 2:25 pm

sir plz email me in ful detail of what are the impacts on business and social life.

5.

AB says:
November 9, 2010 at 8:07 am

thanks for writing such article,i take lot of help from your article.
 6.

fahad says:
November 10, 2010 at 5:54 am

its give me great help.

7.

nosheen says:
December 6, 2010 at 3:08 pm

its is very important nd help full most for students

8.

hira says:
January 11, 2011 at 5:27 pm

great done!!

9.

rija azeem says:

January 23, 2011 at 8:00 pm

sir i want to know about the factors to over come inflation and its a wonderful article.
 10.

rija azeem says:

January 23, 2011 at 8:01 pm

sir i want to know about the factors to over come inflation.

11.

HamidUllah says:
January 30, 2011 at 9:11 pm

Sir ths s very in4mative and can help the students 2 knw abt iflation but if U mention th8 how 2 tackle

inflation as wel thn ths vill be more in4mative thanx .

12.

Azhar says:
February 14, 2011 at 12:38 pm

thier should be details from IMF side the rest is fne …

13.

Rehmat says:
February 21, 2011 at 4:56 pm

Its highly informative article but sir give a another article to mention what r the impacts of inflation on our

business and economy.

 14.

Amjad Soomro says:

March 6, 2011 at 4:20 pm

great work done by lady who wrote the causes of inflation

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