Apr 302008

By Aftab Ahmad Khan

Inflation, which is a phenomenon with momentous economic, social and political consequences, may be broadly defined as a sustained increase in the general price level. It may, however, be noted that all prices need not rise together. Relative prices may increase at varying levels, but in the process push up the general price level. Cyclical swings in prices cannot be termed as inflationary e.g. wheat shortfalls in one season may cause its price to rise but the next year normal production could adjust its price to equilibrium level. The causes of inflation have been much discussed in economic literature and policy debates. There is, however, little disagreement that in the long run inflation is primarily a monetary phenomenon. High rates of price increase cannot be sustained for extended periods without corresponding increase in money supply. The link between monetary growth and inflation is empirically well established for high inflation countries but adjustment lags and shifts in money demand functions tend to weaken the short run correlation in countries with more moderate rates of inflation.

Monetisation of the fiscal deficits is frequently the major source of excessive monetary expansion in developing countries. Developing countries resort to monetary financing of fiscal deficits to a greater extent than industrial countries. This is because of the structural weaknesses of public sector financing in developing countries, which are typically characterised, as in our case, by narrow tax bases, low elasticity of public revenue as well as under-developed capital markets and low private savings. Although a sustained rise in inflation is only possible, if it is accommodated by inappropriate fiscal and monetary policies, episodes of high inflation can be triggered by other developments such as large depreciation of exchange rates, adverse supply shocks, rise in import prices, excess of wage claims over productivity growth, and monopolistic/ oligopolistic market structures.

Structural reforms may also create temporary inflationary pressures, for example when prices are being de-controlled and subsidies cut.

Many economists have frequently emphasised that inflation is more than an economic problem. This is because of their belief that money supply in a modern economy is a “sociologically determined variable.” Behind the excessive money supply, lie complex socio-political forces struggling over the distribution of income and wealth. Various groups, strata and classes in contemporary economies are engaged in an organised struggle over distributive shares. This distributional struggle is not new but it has acquired certain new dimensions, which compel the state to continuously increase the supply of money.

In a free polity particularly, a large number of groups and sections of people pressurise the elected government to accommodate their demands. These groups include organised labour, industrialists, traders, defence personnel, civil servants, farmers etc. These groups do not explicitly ask for inflation, but it is their demands, which if fulfilled usually lead to it. These implicit demands for inflation arise from pressures on the government not to pursues an anti-inflationary policy; these may stem from taxpayers who demand lower taxes or exemptions or who resist extension of the tax base; or these many emanate from beneficiaries who resist expenditure reduction or imposition of appropriate charges or these could be ignited by groups attempting to obtain an increase in their share of national income. Thus, in the short-run, acceleration in money supply and prices represent politically rational response to the various pressures exercised by the beneficiaries of inflation or by those who are going to suffer as a consequence of dis-inflationary measures. It is, however, also a fact that politically motivated inflation if persisted in for a considerable period could assume serious proportions with unwelcome political consequence.

Pakistan has been grappling which inflationary pressures of varying intensity during its entire life of over 60 years as an independent country. According to official statistics, consumer price index (CPI) increased forty fold during the period 1949/50 – 2006/7. The pace of inflation has, however, been varying at different periods of history. Inflationary pressures in the economy during the 1950s and 1960s, were quite moderate; the average annual price increase during the 1950, was 3.0 per cent, while it was 3.2 per cent during the 1960s. During the decade of the 1970s there was worrisome acceleration in inflation attributable to heavy devaluation of the rupee, sharp-rise in oil prices and large monetary expansion (average annual increase of 21 per cent as against average annual growth of 4.8 per cent in Gross Domestic Product). There was deceleration of inflationary pressures during the 1980s with higher real domestic growth of 6.5 per cent on an average basis and a marked reduction in the annual average growth of monetary assets to 13.2 per cent. During the decade of the 1990s, inflationary trends witnessed acceleration with an annual average growth of 9.7 per cent in consumer price index (CPI); monetary assets also witnessed a sharp average annual rise of 21.7 per cent in this decade as against an annual average increase of 4.6 per cent in GDP. There was a welcome decline in inflation rate to 3.6 per cent in 1999-2000. During 2000-2001 to 2003-04, the average annual rate of rise in consumer price index was a modest 3.9 per cent. This impressive performance on the inflationary front was quite remarkable especially in view of the fact that monetary assets expanded at an annual average rate of 15.5 per cent during this period. The low level of inflation during 1999-2000 to 2003-04 can be attributed to improved supply position stemming from output recovery, strict monetary measures leading to lower monetisation of fiscal deficits, depressed international market prices and appreciation of the exchange rate.

Price inflation indicators for FYs 2004-05, 2005-06 an 2006-07 were somewhat disturbing. Inflation as measured by CPI increased by 9.3 per cent in 2004-05, 7.9 per cent in 2005-06 and 7.8 per cent in 2006-07; monetary assets during these fiscal years increased at an annual average rate of 17.9 per cent. During the first nine months of the current FY08, the average CPI based inflation has been estimated at 9.5 per cent period compared to 8 per cent in the same period last year. Food inflation, however, jumped to 13.8 per cent as compared with 10.3 per cent in the corresponding period last year. The wholesale price index (WPI) and sensitive price index (SPI) during July-March FY08 registered increases of 12.59 per cent and 12.87 respectively.

Inflationary trends in recent years have remained uncomfortably high on account of domestic supply side disturbances and the impact of increase in international prices of oil and some key food items.  To control inflation, the State Bank of Pakistan has been pursuing a tight monetary policy during the last three years. It has raised its discount rate to 10.5 per cent. It quite appropriately emphasised in its 2Q Report for FY08, the importance of controlling growing macro-economic imbalances reflected in the widening fiscal and current account deficits which add to inflationary pressures.

The costs of inflation to the economy have been considerable. Inflation has tended to accentuate inequalities and caused strains on our balance of payments. It pushed a sizeable chunk of our resources into socially wasteful channels such as real estate, luxury housing, speculative inventories, bullion and jewellery and foreign exchange balances abroad. Inflation has been responsible for enlivening speculation, stimulating inessential consumption and often generating a climate of industrial strife and instability in the country. Discrimination against the public services is an endemic feature of inflation without indexation. Our public administration has consequently been deeply demoralised and eroded. This is reflected in its inability to enforce laws including those which relate to taxation and other public revenues as well in failure to maintain and improve basic social services like education, health, transport, electricity, water and drainage. In view of these massive economic and social costs,, there is no more important economic agenda item than to beat down the established inflation. In the absence of firm and decisive measures to curb inflation, the expected benefits to the economy from government policies of promoting growth, reducing poverty, enhancing employment opportunities and liberalisation would not accrue. Money represents a claim on a share of society’s output. Stabilising the price level protects that claim while inflation reduces it. It would be inefficient to allow the length of a yardstick to vary over time. Similarly it is inefficient to change the yardstick of economic value.


Years  July-June average     Years  July-June average

1949-50        26.7    1989-90        289.4

1950-51        25.1    1994-95        419.2

1954-55        29.1    2000-01        750.1

1959-60        32.7    2001-02        776.4

1964-65        36.7    2002-03        800.5

1969-70        44.8    2003-04        837.3

1974-75        89.9    2004-05        915.2

1975-76        100.0  2005-06        987.5

1979-80        142.2  2006-07        1064.5

1984-85        213.9  2007-08 (Jul-Mar)     1165.6

Source: Federal Bureau of Statistics

Courtesy: The News, 28/4/2008


 Posted by at 8:20 pm

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