❖ University of the Punjab

:Assignment:
Course Title:
Major issues in Pakistan’s economy
Class:
BS (5th Samester)
Department:
School of Economics
Submitted By:
➢ Haider (1)
➢ Bismah (12)
➢ Humaira (32)
Submitted To:

Professor Ghulam Mujaddad

Assignment Title:
Inflation, Sources of inflation
In Pakistan’s, Policies to
Combat Inflation and
Their Impacts.

Introduction
Inflation refers to the rise in prices that causes the purchasing, power of a nation to fall. The term
‘inflation’
once reffered to increase in the money supply (monetary inflation).
Inflation can also be described as a
decline in the real value of money –
a loss of purchasing power in the medium of exchange which is also a monetary unit of account. When
the general price level increases, each unit of currency buys fewer goods and services, High inflation
may lead to shortage of goods if consumers begin hoarding out of concern that prices will increase in
the future.
Low inflation may reduce the severity of economic recession by enabling the labor market to
adjust more quickly in a downturn, and reducing the risk that a liquidity trap prevents monetary policy
from stabilizing the economy. Monetary authorities i.e. central banks control money supply through the
setting of interest rates, through market operations and through the banking reserve requirements.

➢ Types of inflation
➢ Demand-pull Inflation
➢ Cost-push Inflation
➢ Pricing power Inflation
 1) Demand-pull Inflation:
The most important form of inflation that occurs when the total demand for goods and
services in an economy exceeds the supply available, so the prices for such goods and services rise in the
economy.
2) Cost-push Inflation: The name indicates the cause i.e. costs of
production rise, and forces up the prices of finished goods and services. Often a rise in wages in
excess of any gains in labor productivity is what raises unit costs of production and thus raises
prices.
3) Pricing power Inflation:
It occurs whenever business in general decide to boost their prices to increase their profit
margins. This does not occur normally in recessions but when the economy is booming and sales are
strong.

▪ Causes of inflation
There are many causes of inflation, depending on a no.of factors.

1) Excess Money printing:

Inflation can happen when governments print an axcess of money to deal with a crisis but don’t have
access at backed, usually govts are allowed to print only that amount of currency that is equal to gold
available to that country. As a result, prices end up rising an extremely high speed to keep up with the
currency surplus, in which prices are forced upwards because of a high demand.
2) High production cost:
Another common cause of inflation is a rise in production costs, e.g. if Raw materials increase in
price, this leads to the cost of production increasing which in turn leads to the company increasing
pricing to maintain steady profits. Rising labor costs can also lead to inflation.
3) International lending and national debts:
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.
4) Federal taxes:
Inflation may also caused by federal taxes on consumer products such as cigarettes or fuel. As the
taxes rise, suppliers often pass on the burden to the consumer; however, once prices have increased,
they rarely go back, even if the taxes are later reduced.
e.g. a rise in excise duty on cigarettes, an increase in fuel duties.

▪ Effects of inflation
Most effects of inflation are negative, and can hurt individuals and companies alike, below is a list of
negative, as well as positive effects of inflation.

▪ Negative Effects
➢ Hoarding:
In this case, people will try to get rid of cash before it is devalued, by hoarding food and other
commodities creating shortages of the hoarded objects.
➢ Increased Risk-Higer uncertainties:
Uncertainties in business always exist, but with inflation risks are very high, because of the
instability of prices.
 ➢ Fixed income recipients will be hurt:
Because while inflation increases,
their incomes don’t increase, and therefore their income will have less value over time.
➢ Lower national saving:
When there is a high inflation, saving money would mean watching your cash decrease in value
day after day, so people tend to spend the cash on something else.
➢ Existing creditors will be hurt:
Because the value of the money they will receive from their borrowers later will be lower than
the money they gave before.
➢ Distortion of relative prices:
Usually the prices of goods go higher, especially the prices of commodities.
➢ Causes and increase in tax bracket:
People will be taxed a higher percentage if their income increases following an inflation increase.
➢ Causes business life cycles:
Many companies will have to go out of business because of the losses they incurred from
inflation and it’s effects.

▪ Positive Effects of inflation:

➢ It can be benefit the inflators ( those responsible for the inflation).
➢ It can benefit early and first recipients of the inflated money ( because negative effects of
inflation are not yet there).
➢ It can benefit the cartels, and can cause price control set by cartels for
their own benefits.
➢ It might relatively benefit the borrowers who will have to pay the same amount of money they
borrowed ( Fixed interests), but the inflation could be higher than interests; therefore they will
pay less money back.
e.g.
You borrowed $1000 in 2008 with 5% Interest rate and you paid it back in full in 2010, let us
assume the inflation rate for 2005,2006 and 2007 has been 13%, and borrower was charged 5%
of interest, but in actual borrower earrings 8% Of interests, which means you have paid only
around 65-70% of the real value in 3 years.

▪ Sources of inflation in Pakistan

Inflation is one of the major economic issues in Pakistan. Several supply and demand factors could be
responsible for this surge in inflation.

➢ Supply-side shocks:
If occurs can cause large fluctuations in food and oil prices, which impact overall inflation, at
times can be so extreme that these cannot be countered through demand management,
including monetary policy.
➢ Increased domestic demand: First, increased domestic demand can create an output gap,
putting upward pressure on prices. Growth in private consumption on the average remained
over 10% between FY04 and FY06, depicting signs of demand side pressures on price level. The
relationship between growth and inflation depends on the state of the economy. High growth,
without an increase in inflation, is possible if the productive capacity on potential output of the
 economy is growing enough to keep pace with demand. A prolonged phrase of rising inflation in
such a case can have severe consequences for the economy.
➢ Rising trade deficit:
The expectations effect is very important since there is a danger that the current high rate of
inflation can get locked into expectations of inflation. People expect Higher salaries to
compensate for expected increase in prices, speculation in asset prices increases, credit meant
for manufacturing sector diverts to real estate ana stocks markets, and hoarders, profit and rent
speakers become active in expectation of high price in future. All this can have devastating
affect for the prices.
➢ Fiscal policy remained expansionary:. Fiscal policy has remained
expansionary in the last few years. Expansionary fiscal policy fuels domestic demand and puts
pressure on the current account deficit. It widens the investment-saving gap, which has to be
financed externally. Financing of fiscal deficit through money creation adds to inflationary
pressures. Increased govt. borrowing from central bank can have serious consequences for
general price level.
➢ Expansionary monetary policy:
The expansionary monetary policy-high growth in money supply and loose credit policy-was
believed to be contributing to high inflation. Although expansion of credit is usual growth can
have adverse effects on the real variables.
➢ Rising import prices:
Rising import prices are also considered an important factor for inflation. Exchange rate, if
depreciating can also put upward pressure on price level. Increase in prices of goods, such as
petrol, raw materials, etc. makes our imports costlier, impacting on cost of production.
➢ Indirect Taxes:
Indirect taxes, such as sales tax and excise duty raise the prices of consumer goods. This
creates inflationary pressures. On the other hand, direct taxes reduce the take-home income
and have anti-inflationary effect. A substantial increase in support price of wheat is estimated to
have an inflationary effect on consumer prices, particularly food prices.

▪ Analysis of inflation in Pakistan by CPI

In Pakistan, inflation averaged 8% from 1957 until 2015. It became 10.8% in March 2012, From 2003 to
2010, inflation rate in Pakistan was reported 10.15% , reaching historical highe of 25.33% in Aug.2008,
while minimum inflation was recorded at 1.41% in 2003.
Inflation rate reached all-time high of
37.81% in Dec.1973 and a record low of -10.32% in feb.1959. Inflation was reported 4.5% in FY 2015,
2.9 in FY 2016, 4.8% in FY2017, 4.7% in FY2018,
6.8% in FY2019, 10.9%, in 2020 and 8.9% in FY2021.

▪ Policies to control inflation in Pakistan

➢ State Bank policy:
The main policy used by The State
Bank Of Pakistan to control inflation in monetary policy ( changing interest rates). This policy
takes certain steps to control inflation.
1) Higher interest rates (tightening Monterey policy)
 2) Reducing budget deficit (deflationary fiscal policy)
3) Control monetary supply ( control of monetary being created by the govt.)
4) Decreasing govt.expenditures, reducing private spendings and non development budget.
5) Increasing taxes on private business
6) Ensure balance between demand and supply.
Higher interest rates reduce demand in the economy, leading to lower inflation.
7) Higher rate of income tax could reduce spending, demand and inflationary pressures.

❖ Conclusion
Inflation effects different sectors of the economy ( Effect on the distribution of income and wealth,
Effects on production, Effects on govt, Effects on balance of payments, Effects on Monetary policy,
Effects on social sectors, Effects on political environment ) and different classes of people (debtors and
creditors, salaried class, wage earners, fixed income group, investors and share- holders, Businessmen,
Agriculture ).
A reasonable rate of inflation-around 3.6% is often viewed to have positive effects on national
economy as it encourages investment and production. When it crosses limits, it has negative impacts. It
reduces the Value of money, resulting in uncertainty of the value of gains and losses of borrowers,
lenders and sellers.
This uncertainty discourages saving and investment. Inflation also makes the poor worse off and
widens the gap between the rich and the poor.
For Pakistan, inflation can be bad if it crosses the threshold of 6%, and can be extremely harmful
if it crosses the double digit level. Several supply and demands factors could be responsible for this
surge in Inflation. Supply-side shocks can cause large fluctuations in food and oil at times, can be so
excessive that these cannot be countered through demand management.

*Thank you*