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Role of Inflation and Change in Consumer Buying Power
THE ROLE OF INFLATION AND CHANGE INCONSUMER BUYING POWER
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Role of Inflation and Change in Consumer Buying Power
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
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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
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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
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“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)
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Role of Inflation and Change in Consumer Buying Power
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
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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.
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CHAPTER # 1 INTRODUCTION
1.1 Introduction
1.2 Purpose of Study
1.3 Research Objectives
1.4 Research Methodology
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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.
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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.
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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
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CHAPTER # 2 LITERATURE REVIEW
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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.
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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.
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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
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CHAPTER # 3 INFLATION
3.1 Introduction
3.2 Types of Inflation
3.3 Inflation in Pakistan
3.4 Impact of Inflation in Pakistan
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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”
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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.
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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.
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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
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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.
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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.
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Inflation during 2006-07
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.
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Inflation during 2007-08
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%.
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Inflation during 2008-09
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.
Inflation during 2009-2010
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
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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.
Inflation during 2010-2011
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
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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
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0
5
10
15
20
25
years 2004 2005 2006 2007 2008 2009 2010 2011
years2004
2005
2006
2007
2008
2009
2010
2011
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5
5 http://www.indexmundi.com/pakistan/inflation_rate_(consumer_prices).html
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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
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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.
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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.
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CHAPTER # 4 CAUSES OF INFLATION
4.1 Demand pulls Inflation
4.2 Cost push Inflation
4.3 Monetary policy
4.4 Political Instability
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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
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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:
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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
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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
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
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.
10 http://useconomy.about.com/od/glossary/g/Contractionary.html
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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
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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.
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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
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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
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CHAPTER # 6 CONTROLLING INFLATION
Monetary Policy Control Inflation
Role of Central Bank and Government
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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
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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
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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
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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)
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CHAPTER # 7 CONCLUSION AND RECOMMENDATION
7.1 Conclusion
7.2 Recommendations
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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
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
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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.
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.
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Role of Inflation and Change in Consumer Buying Power
REFERENCES
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Role of Inflation and Change in Consumer Buying Power
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