April 26 and Cost Push 2012 Factors - WordPress.com · 02.04.2013 · effect of Demand Pull and...

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Institute of Business Management Inflation is a Combine effect of Demand Pull and Cost Push Factors April 26 2012 Evidences from Pakistan Economy The objective of this paper is to investigate the relationship between Inflation and, demand pull and cost push factors combined. For this purpose the historical data, on Economy of Pakistan, has been obtained from the SBP (State Bank of Pakistan) website and FBS (Federal Bureau of Statistics), while an analytical and empirical study has been conducted to evaluation the subject. By Adeel A. Siddiqui (2010 – 1 – 27 – 11262)

Transcript of April 26 and Cost Push 2012 Factors - WordPress.com · 02.04.2013 · effect of Demand Pull and...

I n s t i t u t e o f B u s i n e s s M a n a g e m e n t

Inflation is a Combine effect of Demand Pull and Cost Push Factors

April 26

2012 E v i d e n c e s f r o m P a k i s t a n E c o n o m y

T h e o b j e c t i v e o f t h i s p a p e r i s t o i n v e s t i g a t e t h e r e l a t i o n s h i p b e t w e e n I n f l a t i o n a n d , d e m a n d p u l l a n d c o s t p u s h f a c t o r s c o m b i n e d . F o r t h i s p u r p o s e t h e h i s t o r i c a l d a t a , o n E c o n o m y o f P a k i s t a n , h a s b e e n o b t a i n e d f r o m t h e S B P ( S t a t e B a n k o f P a k i s t a n ) w e b s i t e a n d F B S ( F e d e r a l B u r e a u o f S t a t i s t i c s ) , w h i l e a n a n a l y t i c a l a n d e m p i r i c a l s t u d y h a s b e e n c o n d u c t e d t o e v a l u a t i o n t h e s u b j e c t .

By Ad e e l A. S i d d iq u i ( 2 01 0 – 1 – 2 7 – 1 12 6 2)

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L e t t e r o f A c k n o w l e d g e m e n t

To whom it may concern.

This letter is to acknowledge the supervis ion, effort and sincer ity, offered by the course instructor Mr. M. Ashraf Janjua, to teach the subject and provide adequate guidel ines for the purposeful compl iance of this thesis. The accomplishment of this thesis is a result of a combine effort made by the researcher and the supervisor (Mr. M. Ashraf Janjua), dur ing the term spr ing 2012. The object ive to wr ite th is Thesis is to invest igate the relationship between Inflation and the factors Cost Push and Demand Pul l together, in the Economy of Pakistan. I hereby acknowledge that dur ing the 23rd session of Seminar in Economic Pol icy conducted by Mr. M. Ashraf Janjua, dated 16th

April ’12, provided signif icant guidance and direct ion, to accomplish the subject thesis.

Gracias,

Adeel A. S iddiqui 2010 – 1 – 27 – 11262

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L e t t e r o f T r a n s m i t t a l

To,

Mr. Ashraf Junjua, Institute of Business Management,

Dear S ir ,

I am submitt ing this thesis on “Inflation is a combined result of cost push and demand pul l factors”, which is based on the evidences from Pakistan Economy. To serve the purpose of this research, I have used few authentic data and l iterature sources on the internet, while to invest igate and conduct an analyt ical and empir ical research and stat ist ical analysis, I have used SPSS software support. The results from this research are subjected to vary for the evidence from various different structures and sizes of other economies.

Gracias y Saludos,

Adeel A. S iddiqui 2010 – 1 – 27 – 11262

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A b s t r a c t

The object ive of th is paper is to invest igate the relationship between Inflation and, demand pul l and cost push factors combined. For this purpose the histor ical data, on Economy of Pakistan, has been obtained from the SBP (State Bank of Pakistan) website and FBS (Federal Bureau of Stat ist ics), while an analytical and empir ical study has been conducted to evaluat ion the subject.

There are several controllable and uncontrol lable causes of Inflation, but in the case of th is invest igat ion, the correlat ion between Inflation and cost push and demand pul l factors combined has been taken into considerat ion. The theoretical framework of the study is designed to study responses of changes in Government Expenditure as generating aggregate demand and changes in exchange rate as pushing the cost, generating a combined effect on Inflation.

T a b l e o f C o n t e n t s Letter of Acknowledgement .............................................................. i iLetter of Transmittal .......................................................................... i i iAbstract ............................................................................................. ivTable of Contents ............................................................................... 1Introduction ........................................................................................ 3Literature Review ............................................................................... 4

1. Note on Inflation ..................................................................... 71. Inflation, Deficit .................................................................... 82. Inflation, Credit ..................................................................... 83. Inflation, Scarcity .................................................................. 84. Inflation, Prof it ...................................................................... 85. Inflation, Ol igopol ist ic (Pr icing Power) ................................ 86. Inflation, Tax ......................................................................... 87. Inflation, Build-In ................................................................... 88. Inflation, Development ........................................................ 99. Inflation, F iscal ...................................................................... 910. Inflation, Populat ion ............................................................. 911. Inflation, Sectar ian ............................................................... 912. Foreign Trade Induced Inflation .......................................... 9

2. Factors of Inflation .................................................................. 91. Cost Push Inflation ................................................................ 92. Demand Pul l Inflation ......................................................... 10

3. Combined effect ................................................................... 12Research Methodology ................................................................... 12

1. Hypothesis .............................................................................. 122. Theoretical Framework .......................................................... 123. Technique .............................................................................. 12

Data Subject ive Analysis ................................................................. 131. FY ‘01 ..................................................................................... 132. FY ‘02 ..................................................................................... 133. FY ‘03 ..................................................................................... 144. FY ‘04 ..................................................................................... 145. FY ‘05 ..................................................................................... 146. FY ‘06 ..................................................................................... 147. FY ‘07 ..................................................................................... 158. FY ‘08 ..................................................................................... 15

Inf lation i s a Combine effect of Demand Pul l and Cost Push Factors <Table of Contents

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9. FY ‘09 ..................................................................................... 1510. FY ‘10 ..................................................................................... 15

Empir ical Test ing .............................................................................. 161. Correlation Test ing ................................................................ 16

Interpretation ............................................................................. 162. Covariance ............................................................................ 16

Interpretation ............................................................................. 173. Regression .............................................................................. 17

Interpretation ............................................................................. 17Interpretation ............................................................................. 18

4. Two Way ANOVA Test ............................................................ 19Interpretation ............................................................................. 19

Trend Analysis ................................................................................... 19Interpretation ............................................................................. 20

Results ............................................................................................... 20Conclusions ...................................................................................... 21Works Cited & References ............................................................... 21

List of Tables

Table 1: Data Set ............................................................................. 13 Table 2: Correlation ......................................................................... 16 Table 3: Covariance ........................................................................ 16 Table 4: Regression - Inflation due to G. Exp Change ................... 17 Table 5: Regression - Inflation due to Ex. Rate Change ................. 18 Table 6: Two Way ANOVA Test......................................................... 19

List of Figures

Figure 1: Trend Comparison ............................................................. 20

Inf lation i s a Combine effect of Demand Pul l and Cost Push Factors Introduction

By Adeel A. S iddiqui (2010 – 1 – 27 – 11262) 3 | P a g e

I n t r o d u c t i o n During the past few decades, despite of other economic problem, inflation has s ignif icantly drawn the attention of economist , al l around the world. The debate to f ind the possibil it ies, to achieve two major macroeconomic goals of utmost importance that is low rate of inflation and low rate of unemployment, has been primary interest amongst al l economist . Many theor ist and researcher devoted their labors in f inding the determinants and the resultants of inflation, in the overal l framework of the economies, while aiming to f ind ways to achieve reasonable sustainabil ity and control over them. The nature and structure of var ious economies with respect to the strategic geo – pol it ical location reacts discordantly and require several different measures to achieve optimum control over inflation. On a broader spectrum each factor of inflation working independently, can be considered to create s imilar effects, in every s ize, shape, nature of economy, as the relationship between Supply and Demand is the s implest explanation and a proven postulate as a whole, for every one of them.

Dur ing the present regime in Pakistan h igh inflation has been emphasized as a persistent problem, leading and creating diff iculties, for both Government and the governed. Th is has been superf icial ly indicated and identif ied that the inflation problem is a resultant of improper coordination of F iscal and Monetary pol icies and deviated implementations, at large. Moreover it is destabil iz ing the entire economy. S ignif icant in it iat ives had been taken by SBP, through increasing discount rates and other contract ionary measures, but due to heavy Government borrowing to f inance Fiscal deficits specif ical ly, created a nul l ifying effect and the desired outcomes were not achieved. This study mainly focused the combined effect of cost push and demand pul ls over the inflation. To begin with the invest igat ion about the combined effect of cost push and demand pul l factors , on, pr imarily they must be surfaced. In the following section there is a quick overv iew on inflation and its factors and determinants.

Inf lation i s a Combine effect of Demand Pul l and Cost Push Factors Literature Review

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L i t e r a t u r e R e v i e w Fol lowing is the comprehension on inflation developed from text reading and l iterature review, of the papers mentioned in the references and citat ions.

Inflation is a persistent increase, in the general price level of all goods and serv ices in a certain economy, dur ing a certain per iod, which leads decl inat ion in the purchasing power of the medium of exchange. Any determinant of inflat ion can only base on either excessive demand or shortage of supply. The factors based on demand are increase in money supply, expenditure, income, growth of private sector etc. whereas the factors based on supply are shortages due to short production of consumer goods, scarcity of factors of production, exports boom, industr ial issues, etc.

Inflation disturbs different classes of residents and sectors of economy. Generally inflation is welcomed by debtors, producers and businessmen, while the effected of inflation can be from f ixed income group, salar ied class, agr icultur ists, businessmen, creditors and debtors, shareholders and investors, and wage earners. Inflation disturbs government sector, production sectors, wealth and income distr ibut ion, pol it ical and social environments and monetary pol icy.

Determinants of Inflation are based on various factors, and can be a resultant of certain measures taken by the government. For example, an expansionary monetary pol icy is made to work in and with any calamitous condit ion. Government borrowing can lead to excess pr ints of money in it ial ly result in devaluat ion of currency and ultimately increases the purchasing power of the consumers . Due to inflat ion, people gets driven to purchase the commodit ies, instead of saving, which result in r is ing demand and can cause shortage of commodit ies, and ultimately it wil l increase the pr ice level of general goods and serv ices.

Common factors and causes of inflation is the increase in production cost and aggregate demand. These factors wil l ul t imately increase pr ice of f inal good or serv ice. Whenever the raw mater ial or component pr ices levels increases, cost of production also increases and to absorb the cost of production,

Inf lation i s a Combine effect of Demand Pul l and Cost Push Factors Literature Review

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without lower the profit margins, the producers and business increase the pr ices of their goods and serv ices, with the only aim to sustain and maintain their prof its. Federal and provincial taxes which are imposed on the consumer goods, may also cause inflation and as there is an increase in tax levels, pr ices are subjected to increase as wel l , by the producers and suppl ier, to pass on the burden, which is ult imately bared by the consumer.

Dur ing past few decades, Economy of Pakistan has shown a rapid economic growth, despite of the existence of several huge problems with in the economy, which are required to be solved as soon as possible. Amongst few problems headl ining the concerns , inflation is drawing the attention of the economists, and now with 13% dur ing FY ’11 inflation is heading the l ist . Few signif icant factors causing inflat ion to increase, is an increase in ut il ity tar iff s due to shortage of ut il it ies, excise dut ies, and fuel prices. Every s ingle and indiv idual factor contr ibutes and effects in combination with other, resulting in the increase in inflation rate.

Several necessary measures and steps are required to be taken by the government, in order to provide rel ief, to the general publ ic , in buying necessity goods. One of the s ignif icant measures taken by the governments, in the h istory, is the provis ional offer ing and distr ibut ions of the wheat flour and sugar at relatively low prices at the Ut il ity Stores Corporat ion. The outlets of Ut il ity Stores Corporat ion have been establ ished in various areas to offer price relaxation to the people with medium and low real income groups.

A remarkable secondary measure, to control inflation is to import many goods special ly commodit ies, from India through land routes, which wil l definitely help in easing the inflat ion problem. But it has become such a severe issue that cannot be resolved without a properly planned strategy. Unfortunately, the government of Pakistan was unable to make and implement any proper and effective strategy, which can help it to control this huge problem of inflation, as secondary measures cannot control this pers istent problem.

The economy of Pakistan majorly rel ies on the production from agriculture sector, but unfortunately, the government has been ignor ing this sector, constantly, which is result ing into a relatively

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slower growth rate in this part icular sector. Neither fore ign investments are encouraged to invest and amel iorate th is sector and increase its productiv ity, nor does the government itsel f show their interest for the growth of this sector, by taking measures such as providing adequate subsidies and relaxations. Dur ing the past few years, increase in oil pr ices, in the international markets, i s one of the signif icant factors of the evident increase in general pr ice levels and the government concerns are lower than the ignorant level. The government is unable to control this problem, although if the fuel prices are controlled, their s ignif icantly affect the cost of production and ult imate increasing the pr icing of every goods and serv ice, can be brought to an acceptable level. I f somehow the oil prices decreases and maintained at a certain level, automatical ly the cost of production and ultimately the pr icing of goods and services wil l also decreased and sustained and the economy wil l be stabil ized. Moreover, due to the reduction in cost of production, aggregate supply wil l also increase, matching the aggregate demand.

Dur ing the present regime, Pakistan witnessed several shocks and depression, which are somewhat l inked and can be part ial ly considered as a resultant of incontrollable inflation, within the economy. This persistent issue and inevitable problem must be solved and brought to the government control , primarily, so that the economy can be put on the road on development and growth. A proper and effect ive strategy must be formulated and implemented to serve the very purpose of governance. Measures must be taken to control and maintain the pr ice level of necessity goods, and these must be pr ior it ized over the durables and luxur ious goods. Certain provis ions must be formulated to rel ief the agricultural sector, e ither by providing adequate subsidies or taxat ion based relaxat ions. Government must provide assistances to develop and increase domest ic productiv ity, despite of the imports and such measure to attract and encourage foreign investment and management into the publ ic and pr ivate sector must be taken. In addit ion to these, a candid and efficient monitor ing, project ing and evaluat ing system must be establ ished and deployed, which must accurately evaluate the effectiveness of each measure taken to eradicate exist ing and projected problems.

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One of the most s ignif icant and noteworthy, root causes of inflation is the unl imited government spending. Dur ing this regime, government borrowings had increased to the highest l imits in the history of the country, which is due to f inancing of consistent budget def icit . These budget def icits are the eminent results of the uncontrollable government spending.

Stagnant Inflation is not good for the economy as well . One of the basic disadvantages of stagnant inflation is that it reduces the standard of l iv ing, for the reason of high prices of goods and services. The r ise in inflat ion must not be more than the rise in the salar ies and wages of average individuals, because th is can lead to the reduction in purchasing power of the people; they may not be able to purchase required goods and serv ices, and ult imately decreasing the l iving standards. To facil itate the prevention of poverty in a country, money supply must be adequate , maintained and well managed and it must not be excessive, as extraordinary monetary expansion can result in inflat ion, as well . The adaptat ion of several prevention tool, does not ensure l imit ing inflat ion to a desirable level, there is a need of cont inuous and prompt responses to the market condit ion, which can only help the government in maintain ing inflation.

1 . N o t e o n I n f l a t i o n Inflation being one of the key macroeconomic goals has been widely studied by many economists and researchers. There is a basic def in it ion of Inflation.

Inflation is a constant augmentat ion, over a certain per iod, in the general price level of all goods and serv ices in a certain economy, which leads decl inat ion in the purchasing power of the medium of exchange. Inflation is a resultant of pressures generated by several internal and external sources and from either s ides of the economy, which is supply and demand. Inflation Rate is the percentage change in certain pr ice indices over a per iod, normal ly CPI , Consumer pr icing index, in the case of Pakistan.

New scient if ic defin it ion of Inflation is that it is caused when one sector tr ies to l ive of another sector in an economy.

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This def init ion of Inflation has evolved through various stages with the developments in the study of economies, and these can be classif ied by their causes, into fol lowing few types, which can coexist in an economy.

1. Inflation, Deficit When the Inflation is caused due to deficit f inancing, it is cal led deficit Inflation.

2. Inflation, Credit Inflation caused by excess back credit and money supply, in the economy.

3. Inflation, Scarcity I t is a type of inflation which is caused due to scarcity, shortages either natural ly or artif icial ly created. Natural ly means of creating such inflation can be catastrophe, drought, etc due to which the supply goes below the level of demand, while art if icial ly it i s caused by hoarding, which is il legally done by traders by holding commodit ies and create art if icial shortfall of supply, to earn more profits. This causes an abrupt increase in their pr ices.

4. Inflation, Profit I t is a type of inflation which is caused due to the increase in the profit margins, by investors and businessmen, and ult imately results in increasing pr ice levels.

5. Inflation, Oligopolistic (Pricing Power) I t is a type of inflat ion which is caused when businesses increase their pr ices with the object ives to generate more profits, and knowing that their product demand is pr ice inelastic.

6. Inflation, Tax I t is caused due to the increase in the price levels by passing on the burdens of indirect taxes.

7. Inflation, Build-In I t is caused due to the increase in pr ices by the increase in the increase in salar ies and wages, to adapt with expectat ions and demands of the workers.

Inf lation i s a Combine effect of Demand Pul l and Cost Push Factors Literature Review

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8. Inflation, Development Increase in pr ices due to the development expenditures. Th is can be explained as the effect on prices due to the increase in demand due to the increase in incomes.

9. Inflation, Fiscal Inflation caused due to the increase in government expenditure , which results in increasing the demand. I t may cause f iscal deficits as wel l .

10. Inflation, Population A remarkable increase in the population can increase demand signif icantly, which ultimately results in rais ing pr ices of product, to attain equil ibr ium.

11. Inflation, Sectarian I t is caused when a sector or industry increases its pr ice levels with a fairly larger effect on the economy.

12. Foreign Trade Induced Inflation Inflation induced due to foreign trade, can be further classif ied into two categories.

a) Export Boom Inflation I t can result due to the increase in exports which cause shortages for domestic consumption. I t ul t imately results in the abrupt increase in the pr ices.

b) Import Price Hike Inflation I f the prices in domest ic markets increase due to the inflation in the foreign markets, as a result of imports it is Import Pr ice Hike Inflations.

2 . F a c t o r s o f I n f l a t i o n Every type of inflation by their causes can be general ized into two broad categories.

1. Cost Push Inflation I t is due to the increase in cost of producing goods and serv ices which results in s ignif icant increase in the prices. When the prices of goods and services r ises as a responses to the increase in the

Inf lation i s a Combine effect of Demand Pul l and Cost Push Factors Literature Review

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producing costs, when businesses aim to maintain the prof it margins, cost push effect occurs. Fol lowing are few reasons for cost push factor.

a) Cost of the Components/Raw Mater ials Cost of Components/Raw Mater ials, if increase in the local exchange medium, it s ignif icantly increases the f in ished goods or services pr ice levels. I t can be a result of global increase in commodity pr icing. I t can be a result of External Economic Shocks, due to unexpected volatil ity of pr ices of internat ional ly traded commodit ies, which can be imported from the internat ional market.

b) Cost of Labor Cost of Labor general ly increases if the level of unemployment is s ignif icantly low, which leads to imbalance between the increase in wages and increase in productiv ity, due to the high bidding for pay. Normal ly Labor bid h igh in fear of inflation due to unemployment and to protect their real income. I t can be a persistent problem for industr ies if they are labor intensive. These industr ies ult imately pass on their cost to the end consumers, by increasing the pr ices.

c) Imposition of indirect taxes The burden of Indirect taxes, imposed by the government on the producers, is passed on to the customers, by increasing the pr ices. This h ighly depends upon the price elasticity of demand and supply.

d) Exchange Rate The changes in exchange rates, devaluat ion of currency results in the increase of the cost of goods imported. This can cause a s ignif icant increase in the pr ices of imported goods or the goods produces with imported goods.

2. Demand Pull Inflation I t is caused due to imbalance between aggregate demand and aggregate supply and that causes acute r ise in the pr ices of goods and services.

Signif icant reason behind th is factor is ful l employment of resources, which leads to the increase in aggregate demand.

Inf lation i s a Combine effect of Demand Pul l and Cost Push Factors Literature Review

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There are several reasons causing increase in aggregate demand in the economy which are as fol lows.

a) Exchange rate The depreciat ion of Exchange rate can be a consequence of the reduction in the pr ice of the export goods with respect to the pr ice increasing pr ice of the import goods. Aggregate demand with in the economy may increase due to the shortage as there is more emphasis on exports, as foreign buyers wil l demand more due to the decrease in the price in terms of their currency. Th is can result in inflations with in the economy due to shortage. I f the economy is employing ful l resources then the prices wil l increase.

b) Direct/indirect taxation Reduction in direct taxes increases real disposal of income, which can cause a s ignif icant increase in aggregate demand, as the room to buy more, with in the incomes may increase, and cause Demand pul l . But if there is a reduction in indirect taxes, the pr ices of consumer goods, wil l decrease and then create the same scenario, of increasing real disposal of income, creat ing increase in aggregate demand.

c) Money supply There can be monetary reasons as well , which can cause inflation. These can be caused due to excessive supply of money in circulat ion, which is more than the requirements of f inancing the transactions.

d) Government Spending Higher government spending can incur f iscal deficits and require borrowing from the central back, which ultimately increases the influx on money supply into the circular f low, which can cause an increase in the demand generated by both the Government and from the Governed due to the increase in money supply.

e) Interest Rates A drast ic decrease in interest rates can dr ive excessive demand, as the trend from investments in banks wil l shift to investments in commodit ies or even in disposal.

f ) Economic growth Fast economic growth can cause increase in exports, which can generate a demand pul l for constituents of the goods exported.

Inf lation i s a Combine effect of Demand Pul l and Cost Push Factors Research Methodology

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g) Improved business confidence Consumer preferences and loyalty, prompts business to increase their pr ices and earn higher prof it margins.

3 . C o m b i n e d e f f e c t To accomplish the subject thesis, that is the invest igat ion of the combined effect of Cost push and demand pul l factor, and to narrow down the research to be conclusive, for cost push I have considered changes in exchange rate and for demand pul l changes in Government Expenditure, whereas for Inflation I used CPI rate of change.

R e s e a r c h M e t h o d o l o g y Fol lowing is the research methodology I used to invest igate and conclude my research.

1 . H y p o t h e s i s The Hypothesis of th is research is as follows

H0: Inflation is a combined effect of Cost Push and Demand Pul l factor

H1: Inflation is not a combined effect of Cost Push and Demand Pul l factor

2 . T h e o r e t i c a l F r a m e w o r k To invest igate the subject of the thesis I have selected the data from FY ’01 to FY ’10. This per iod have Inflation rate on the basis of CPI , Changes in Total Government Expenditures, and changes in the Exchange Rate, where I have considered Inflation Rate on the Basis of CPI as dependent Var iable ‘Y’ on which we are invest igat ion the effect of Changes in Total Government Expenditures, and changes in the Exchange Rate as independent Var iable ‘X1’ and ‘X2’ respectively. The independent variable are dr iven from non – Development expenditure and average Exchange Rate for respective years

3 . T e c h n i q u e To draw conclusion from th is study, I have conducted a subject ive analysis, year by year. For Trend analysis I used Excel, to identify

Inf lation i s a Combine effect of Demand Pul l and Cost Push Factors Data Subject ive Analysis

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the lagging and leading relat ionship. For empir ical test ing I used SPSS Primarily to see the correlation which is to evaluate the extent of relationship between variables, covariance which is to evaluate how they change together, and Regression analysis, to evaluate the signif icance of each independent Variable, etc. The secondary test ing technique I used is to f ind the combine effect of both independent var iables on Inflation, is two way ANOVA without Replacement.

Fol lowing is the data set for the invest igat ion.

Table 1: Data Set

Years Inflation rate G. Exp Change Ex. Rate Change FY01 4.41% -4.50% 4.24% FY02 3.54% 33.99% 3.55% FY03 3.10% -9.23% -8.14% FY04 4.57% 4.33% -3.09% FY05 9.27% 11.41% 6.66% FY06 7.92% 19.52% 1.02% FY07 7.77% 14.05% 1.15% FY08 12.00% 40.76% 3.95% FY09 20.77% 9.41% 32.41% FY10 11.73% 22.63% 6.75%

D a t a S u b j e c t i v e A n a l y s i s Init ial ly, there is a br ief analysis on the date of each Fiscal Year, with consider ing the other factor precisely.

1 . F Y ‘ 0 1 During the f iscal year general inflat ion rate was about 4.41% in dispar ity to the inflationary rate dur ing late 90s that was in double f igures.

The Total Government Expenditure has been decreased by 4.5%, while the exchange rate depreciated by 4.24% of the average of the last Fiscal Year

2 . F Y ‘ 0 2 During the f iscal year inflation rate reduced by 0.9%, br ing it down to 3.54%, whereas the total government expenditure increased by

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34%. Th is shows that dur ing that period the monetary pol icy was very strong in control l ing the money supply.

There is a substant ial increase in the exchange rate, which is 3.55%, lower than what was witnessed dur ing last f iscal year.

3 . F Y ‘ 0 3 During the f iscal year inflation rate reduced more by 0.4%, br ing it down to 3.1%, whereas the total government expenditure also decreased by 9.23%. Th is year the exchange rate was also appreciated by 8.14%.

4 . F Y ‘ 0 4 During the f iscal year inflation rate increased by 1.5%, which is 4.57%, whereas the government Non – development expenditure increased by 4.33%. This year the exchange rate was appreciated by 3%.

GDP growth was s ignif icantly remarkable this year, which must have lead to the inflation rate increase. Another important factor of increase in Inflation rate can be the increase in Total Government Expenditure.

5 . F Y ‘ 0 5 During th is year, inflation rate increased by 5%, which is 9.27%, relatively higher than the date from previous years in considerat ion, whereas the government expenditure increased by 11.41%. Th is year the exchange rate was brought down by 6.66%.

The main reason for the substant ial increase in inflation rate was due to the increase in the aggregate demand and due to the natural calamit ies. The productions of several commodit ies were insuff icient to sat isfy the aggregate demand.

6 . F Y ‘ 0 6 During the f iscal year, inflat ion rate decreased by 1.5%, which is 7.92%, whereas the government expenditure increased by 19.52%. This year the currency was depreciated by 1.02%.

By effective monetary pol icy, it was possible to control aggregate demand and control inflation this year.

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7 . F Y ‘ 0 7 The inflation rate dur ing th is year was about 7.77% as compared to the previous year inflation rate that was 7.92%.

This year the government expenditure increased by 14.05% and the currency was depreciated by 1.15%.

8 . F Y ‘ 0 8 The inflation rate dur ing this year was pushed into double digits , which was 12% as compared to the previous year inflat ion rate that was 7.77%. Th is is almost doubled.

This year the government expenditure increased by 40.76% and the currency was depreciated by 3.95%.

This was mainly because of the heavy government expenditure dur ing last year which resulted into government borrowing to f inance deficits, along with weak monetary pol icy. I t can also be considered that it was also a result of the inflation in the internat ional market.

9 . F Y ‘ 0 9 The inflation rate dur ing this year was the highest with in the per iod under considerat ion, which was 20.77% as compared to the previous year inflat ion rate that was 12%.

This year the government expenditure increase was control led to 9.41% by depreciat ing the currency to the lowest level of 32.41%.

1 0 . F Y ‘ 1 0 The inflat ion rate dur ing th is year remained in double digits, which was 11.73% as compared to the previous year inflation rate has substant ial ly decreased but th is is relatively higher with SPI and WPI taken into considerat ion.

The increase in the inflat ionary rate was due to pr ice increase in electricity, other ut il ity tar iff and fuel . The government borrowings for f inance non – development non-productive expenditures, took the total expenditure up by 22.63%, as provided by the State Bank.

Inf lation i s a Combine effect of Demand Pul l and Cost Push Factors Empir ical Test ing

By Adeel A. S iddiqui (2010 – 1 – 27 – 11262) 16 | P a g e

There can be another factor causing inflation, and that is the substant ial increase in salar ies of government employees that increased their purchasing power instead.

E m p i r i c a l T e s t i n g Fol lowing are few empir ical tests conducted in order to understand the behavior of the var iable with respect ot each other.

1 . C o r r e l a t i o n T e s t i n g The Correlation analysis done on SPSS produced the following table

Table 2: Correlation

Inflation rate G. Exp Change Ex. Rate Change Inflation rate 1

G. Exp Change 0.262783 1 Ex. Rate Change 0.883638 0.134602 1

Interpretation The above table shows that there is a very strong correlat ion between Inflation Rate and Change in Exchange Rate which is 88.36% while the correlation between Inflation and Government Expenditure is 26.27%, which is s ignif icantly low, but is not negl igible. The weak correlat ion can be a result of the impl icat ion from monetary controls dur ing the periods.

2 . C o v a r i a n c e The Covariance analysis done on SPSS generated the following results.

Table 3: Covariance

Inflation rate G. Exp Change Ex. Rate Change Inflation rate 0.002606

G. Exp Change 0.002 0.022234 Ex. Rate Change 0.004576 0.002036 0.010293

Inf lation i s a Combine effect of Demand Pul l and Cost Push Factors Empir ical Test ing

By Adeel A. S iddiqui (2010 – 1 – 27 – 11262) 17 | P a g e

Interpretation The above table shows that the behavior of Exchange rate changes is s imilar but h ighly variable with inflation rate, by showing covariance 0.45%, whereas the covariance between Inflation rate and Government Expenditure shows s imilar changing behavior throughout the period.

3 . R e g r e s s i o n • The regression analysis done on SPSS generated the fol lowing

results for Inflation due to Government Expenditure.

Table 4: Regress ion - Inf lat ion due to G. Exp Change

SUMMARY OUTPUT Regression Statistics

Multiple R 0.262783 R Square 0.069055 Adjusted R Square -0.04731 Standard Error 0.055068 Observations 10 ANOVA

df SS MS F Significance F Regression 1 0.0018 0.0018 0.59342 0.463239 Residual 8 0.02426 0.003033

Total 9 0.02606 Coefficients Standard Error t Stat P-value

Intercept 0.072276 0.024078 3.00178 0.017025 G. Exp Change 0.089966 0.116788 0.770338 0.463239

Interpretation In the result from regression analysis, change in Government Expenditure shows a leading effect on Inflation. The t-stat ist ic is less than 2 which shows that the regression is ins ignif icant, th is impl icat ion is due to the effect of certain other var iable affect ing inflation are miss ing in the theoretical model. The Adjusted R Square shows that there are other var iables absorbing its corresponding effect on inflat ion. There is a possibil ity that the var iables are not normal ly distr ibuted. The Sum of Squared Residual can be interpreted that there are other factors with s ignif icantly higher level of affect on determining inflat ion. The

Inf lation i s a Combine effect of Demand Pul l and Cost Push Factors Empir ical Test ing

By Adeel A. S iddiqui (2010 – 1 – 27 – 11262) 18 | P a g e

complete theoretical model must consist of every var iable, in order to draw the complete picture.

• The regression analysis done below on SPSS generated the following results for Inflation due to Exchange Rate changes.

Table 5: Regress ion - Inf lat ion due to Ex. Rate Change

SUMMARY OUTPUT Regression Statistics

Multiple R 0.883638 R Square 0.780817 Adjusted R Square 0.753419 Standard Error 0.026721 Observations 10 ANOVA

df SS MS F Significance F Regression 1 0.020348 0.020348 28.49913 0.000695 Residual 8 0.005712 0.000714

Total 9 0.02606 Coefficients Standard Error t Stat P-value

Intercept 0.063526 0.009365 6.783191 0.00014 Ex. Rate Change 0.444624 0.083287 5.338458 0.000695

Interpretation In the result from regression analysis, change in Exchange Rate shows a synchronized behavior with Inflation. The t-stat ist ic is greater than 2 which show that the regression is s ignif icant, this impl icat ion is due to the 88% correlation between Inflation and changes in exchange rate. The Multiple R is 88% can be interpreted that 11% of the effect on inflation is due to certain other variable which are miss ing in the theoretical model. There is a possibil ity that the var iables are not normally dist r ibuted. The Sum of Squared Residual can be interpreted that there are other factors with relat ively lower level of affect, rather smoothening effect on determin ing inflation. The complete theoretical model must consist of every variable, in order to draw the complete picture.

Inf lation i s a Combine effect of Demand Pul l and Cost Push Factors Trend Analysis

By Adeel A. S iddiqui (2010 – 1 – 27 – 11262) 19 | P a g e

4 . T w o W a y A N O V A T e s t The two ways ANOVA done on SPSS, for the purpose to invest igate the combined or concurrent effect of independent var iables on inflation, generated the following results

Table 6: Two Way ANOVA Test

ANOVA: Two-Factor Without Replication SUMMARY Count Sum Average Variance

0.04409329 2 -0.00263 -0.00131 0.003821 0.0354 2 0.375404 0.187702 0.046337

0.031002511 2 -0.17369 -0.08684 5.92E-05 0.045714286 2 0.012432 0.006216 0.002758 0.092717012 2 0.180637 0.090318 0.001128

0.07919331 2 0.205328 0.102664 0.017112 0.077711942 2 0.152052 0.076026 0.00832 0.120039473 2 0.447133 0.223567 0.067762 0.207677785 2 0.418179 0.20909 0.026439 0.117300677 2 0.293791 0.146896 0.012611

G. Exp Change 10 1.423761 0.142376 0.024704 Ex. Rate Change 10 0.48488 0.048488 0.011437 ANOVA

Source of Variation SS df MS F P-value F crit Rows 0.182995 9 0.020333 1.286246 0.356884 3.178893 Columns 0.044075 1 0.044075 2.788162 0.129303 5.117355 Error 0.142271 9 0.015808

Total 0.36934 19

Interpretation The Sum of Square Residual shows that the two independent var iable, are 18% concurrent with each other, while in columns they are not normal ly distr ibuted, and their combined effect on Inflation is 36.9%, which is due to the absence of other variables with in the framework. I have only taken only one factor for each of the Cost Push and Demand Pul l Factors.

T r e n d A n a l y s i s For Trend Analysis I have generated the trend on Excel.

Inf lation i s a Combine effect of Demand Pul l and Cost Push Factors Results

By Adeel A. S iddiqui (2010 – 1 – 27 – 11262) 20 | P a g e

Figure 1: T rend Comparison

Interpretation After analyzing the Trend, we can see that there the exchange rate concurrently effect the rate of inflation, in a posit ive manner, while Government expenditure has a l imited but leading effect on inflation.

R e s u l t s Fol lowing are the results drawn from the study.

1. According to this study, we can say with 95% confidence that Inflation is not a combine effect of Cost push and demand pul l factors, as the two independent variables only have 36% concurrent effect on Inflation.

2. The study shows that due to the absence of several other var iables, the hypothesis cannot be conclusive with 95% level of confidence.

-20.00%

-10.00%

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10

Trends

Inflation rate G. Exp Change Ex. Rate Change

Inf lation i s a Combine effect of Demand Pul l and Cost Push Factors Conclusions

By Adeel A. S iddiqui (2010 – 1 – 27 – 11262) 21 | P a g e

C o n c l u s i o n s We can draw fol lowing conclusions from the study.

1. Exchange Rate as a s ingle Independent Variable can determine the rate of inflat ion

2. Changes in Government Expenditure have a leading effect on Inflation, but this effect can be neutral ized by effect ive monetary pol icies.

3. In combination if al l cost push and demand pul l factors are considered to generate a concurrent effect on inflation, we can get an exact picture.

4. The improvements in effect iveness of Monetary Pol icy can remarkable help the government in controll ing Inflation up to some extent.

5. SBP’s complete control over monetary pol icy is v ital to achieve this macroeconomic goal.

6. Government Expenditure effect on inflation can be neutral ized by monetary controls, but th is can result in reduction in the rate of Economic Growth.

This research is left open to be invest igated with other var iables with in Cost Push and Demand Pul l Factors.

W o r k s C i t e d & R e f e r e n c e s Peña, B. M. (2008). Inf lation Determinants in Paraguay: Cost Push versus Demand Pul l Factors. Brooklyn, NY: Mart in Cerisola.

Salvatore, D. (2001). Principles of Macroeconomics. S ingapore : Addison-Wesley Educational Publ ishers Inc.

State Bank of Pakistan . (n.d.). Retr ieved from http://www.sbp.org.pk/.

Pakistan Bureau of Statistics . (n.d.). Retr ieved from http://www.pbs.gov.pk/.