Inflation Impact on EconomyBy Rafia Ehsan

Inflation means a rise in prices of goods and services in an economy over a period of time. Inflation is caused by some demand side factors (Increase in money supply, Increase in  income,  Black money spending, Expansion of the Private Sector, Increasing Public Expenditures) and some Supply side factors (Shortage of factors of production, Industrial Disputes, Increase in exports (excess exports), Global factors, Neglecting the production of consumer goods).

Inflation effects the different sectors of the economy (Effects on the distribution of income and wealth, Effects on production, Effects on the Government, Effects on the Balance of Payment, Effects on Monetary Policy, Effects on Social Sector, Effects on Political environment) and different classes of the people (Debtors & Creditors, Salaried Class, Wages earners, Fixed income group, Investors and shareholders, Businessmen, Agriculturists).

There are many causes for inflation, depending on a number of factors. For example, inflation can happen when governments print an excess of money to deal with a crisis. When any extra money is created, it will increase some societal group’s buying power. All sectors in the economy try to buy more than the economy can produce. Shortages are then created and merchants lose business. In the end, the price level rises.

Another common reason of inflation is a rise in production costs, which leads to an increase in the price of the final product. For example, if raw materials increase in price, this leads to the cost of production increasing, this in turn leads to the company increasing prices to maintain their profits. Inflation can also be caused by federal taxes put on consumer products. As the taxes rise, suppliers often pass on the burden to the consumer.

In Pakistan, the most important thing is the rise in prices of oil, gas, excise duties and the increase in the utility tariffs. These all has an inflationary impact on the economy. Pakistan, with a population of about 16 million people has undergone a remarkable economic growth during last few years, but the core problems of the economy are still unsolved. Inflation is one of these core problems.

Government claims that in order to keep the prices of essential commodities under control, it has been taking various measures throughout the year. In order to provide relief to the low and fixed income groups, the government has been selling wheat flour and sugar through the outlets of the Utility Stores Corporation (USC) at much lower prices than the market.

 The government has also allowed the import of various items through land routes from neighboring countries. But, all these are secondary measures. Problems like ‘inflation’ and ‘poverty’ can’t be resolved by applying the secondary measures directly, these need strategic planning. Unfortunately, in Pakistan, these core problems have never undergone such a planning process.

Government has never invited foreign investment for the production of basic goods. Agriculture sector, on which the major industries rely for the raw material has not been given sufficient subsidies. The major rise in the prices is because of the

increasing prices of oil (as increased prices of oil increase the cost of production), but no such steps have been taken to control the oil prices.Domestic productions at less cost of production will not only make the availability of goods much easier but Aggregate Supply will also increase, and domestic industry will get developed.

Inflation is one of the obstacles on the way of development. In Pakistan, it has squeezed the major part of the population. It needs to be controlled by strategic planning. Domestic production should be encouraged instead of imports; investment should be given preference in consumer goods instead of luxuries, Agriculture sector should be given subsidies, foreign investment should be attracted, and developed countries should be requested for financial and managerial assistance. And lastly a strong monitoring system should be established on different levels in order to have a sound evaluation of the process at every stage.

Inflation always hurts ones' standard of living. Rising prices mean people have to pay more for the same goods and services. If income increases at a slower rate as inflation, the standard of living declines even if one makes more. So it is the root cause in making and affecting economy and people of the country poor. If we want to control inflation we shall have to inflict strict control over the supply of money and evading any relaxation to the supply of money. This is the most apt way whereby we can control inflation effectively and keep the economy of the country in a strong and stable position.

Bonds

Bonds and other fixed-income securities are highly sensitive to interest rate changes.

A bond is a loan. The issuer, usually a company or government entity, borrows money from the investor who buys the bond.

When interest rates rise, the price of existing bonds falls. That's because investors can get higher rates on newly issued bonds. As a result, the price of old bonds must fall to make them competitive with new ones.

Cuases of inflation:

A standard explanation for the cause of inflation is "too much money chasing too few goods”. This

is also called the demand-pull theory. Here's how it works:

1. For several possible reasons, more money is being spent than normal. This could be

because interest rates are low and people are borrowing more. Or perhaps the government is

spending a lot on defense contracts during a war.

2. There's not enough supply to keep up with the rising demand for homes, cars, tanks,

missiles, et cetera. Manufacturers are producing goods at a slower rate than people are

demanding goods.

3. When supply is less than demand, prices go up.

Another explanation for inflation is the cost-push theory. Here's how that works:

1. For several possible reasons, the cost of doing business starts to go up independent of

demand. This could be because labor unions negotiated a new contract for higher wages, the

local currency loses value and the cost of exporting foreign goods goes up, or new taxes have put

a strain on the bottom line.

2. It's called cost-push inflation because the rise in the cost of doing business pushes the

price of products up.

An increase in the rate will impact the value of stocks, bonds, real estate,

the dollar and gold. Here's a look at how rising rates could affect various

investments

So how do interest rates affect the rise and fall of inflation? Like we said earlier, lower interest

rates put more borrowing power in the hands of consumers. And when consumers spend more,

the economy grows, naturally creating inflation. If the Fed decides that the economy is growing

too fast-that demand will greatly outpace supply-then it can raise interest rates, slowing the

amount of cash entering the economy.

It's the Fed's responsibility to closely monitor inflation indicators like the Consumer Price Index

(CPI) and the Producer Price Indexes (PPI) and do its best to keep the economy in balance.

There must be enough economic growth to keep wages up and unemployment low, but not too

much growth that it leads to dangerously high inflation. The target inflation rate is somewhere

between two and three percent per year.