Essay on “Inflation” for CSS, PMS, and All Judiciary Examinations

This is an essay on “Inflation” for CSS, PMS, and All Judiciary examinations. Inflation is the decline of purchasing power of a given currency over a specific time. A quantitative estimate of the rate at which the decline in purchasing power occurs can be reflected in the increase of an average price level of a basket of selected goods and services in an economy over some period of time. That’s why the governments of the entire world don’t like inflation. So here is a complete essay on the topic of “Inflation” for CSS, PMS, and All Judiciary Examinations.

In this essay, you will learn about how you can measure inflation, the Causes of inflation, what problems inflation can produce.

Essay on “Inflation”

An economic condition characterized by an increase in prices and wages, and declining purchasing power. Inflation is usually measured by changes in the Consumer Price Index (CPI). The result is diminished purchasing power, and frequently a lower rate of savings as wage earners put more of their disposable assets in consumption, and less in long-term savings.

Inflation is a monetary phenomenon. It occurs when there is too much money in circulation relative to the production of actual goods and services. Federal Reserve Monetary Policy is the only
means of controlling inflation, although Fiscal Policy can help as well.

Inflation is regarded as regressive taxation against the poor. The most visible impact of inflation in recent times is its effect on real output, relative prices, taxes, and interest rates. It also discourages saving and promotes consumption. The effect of inflation severity is more social than economic due to the erosion of the real value of money.

The recent inflationary environment in the country may be blamed to some extent for lower deposit growth and lower savings. Historically, Pakistan is accustomed to lower inflation and thus has less tolerance towards higher double-digit inflation. In this backdrop persistence of high double-digit inflation for the third year in a row has become intolerable. The government is pursuing a combination of several policy measures such as the control of the budget deficit through appropriate fiscal and monetary policies. The improvement of agricultural productivity, the fostering of investment to stimulate output, and the constant vigilance on the market situation to ensure the adequate availability of consumer goods to the common man at a reasonable price to bring inflation down to a tolerable and sustainable level.

The year 2010-11 is the most eventful year for world inflation. Inflation poses a serious threat to macroeconomic stability around the world. More worrying thing is that the recent spike in inflation is coming more from food inflation which is detrimental for the poverty situation, According to the ADB study, a 10 percent rise in food inflation is likely to deteriorate the poverty situation by 2.7 percentage points.

Therefore, the recent strategy of containing inflation aims at alleviating poverty on the one hand and safeguard the average consumer against the hardships of rising prices on the other.

The beginning of the current year 2010-11 in Pakistan saw a number of unfavorable factors impacting the supply and demand situation which created imbalances in the economy. Massive floods swept through one-fifth of the country and caused massive damages to crops, livestock, and infrastructure which resulted in a sharp acceleration in the commodity price and a spike in inflation.

The acute shortage of items of mass consumption necessitated substantial imports at rising landed costs. While on the production front, the imported inflation via the pass-through effect of escalating oil prices consequently raised transport freights, the production cost of materials, and a substantial hike in all the consumable items or services.

Some Structural problems of power outages and weaknesses in the supply chains impacted the real sectors’ production performance added yet another push factor to the general price hike trend.

The global prices are also adding fuel to the fire as a commodity and crude oil prices have surged at an unprecedented pace since July 2010. Pakistan’s problem compounded as all price indices of global prices surged at a massive rate.

The pass-through of international prices impacted prospects for domestic inflation. Inflationary forces in many countries tended to become assertive and caused concern to the government and the people alike. Inflation around the world tracked movement in world oil prices through impacts on energy prices and then lagged impacts on other commodity prices. The continued improvement in global economic growth is driving demand for oil and grains in emerging market economies.

Generally, immune countries from global commodity price movement like India and China had reported higher inflation, recently. On a positive note, major price indices have started decelerating in March 2011 after eight consecutive months of brisk increases in all price indices.

In economics increases in the level of prices are called inflation. Inflation is generally thought of as an inordinate rise in the general level of prices. Four theories are commonly used to explain inflation. The first and oldest, the quantity theory, promoted in the 18th century by David Hume, assumes that prices will rise as the supply of money increases. Milton Friedman refi1ed the quantity theory in the mid-20th century, arguing that the prescription for stable prices is to increase the money supply at a rate equal to that at which the economy is expanding.

Economists measure the price level by computing a weighted average of consumer prices or so-called “producer” prices. The value of the average is arbitrarily set equal to one (or one hundred) in a base year, and the index in any other year is expressed relative to the base year.

Inflation occurs when the price level rises from one period to the next. The rate of inflation expresses the increase in percentage terms. Thus. a 3 percent annual inflation – rate means that, on average, prices rose 3 percent over the previous year. Theoretically, the rate of inflation could be by the hour or the minute.

Deflation is the opposite of inflation: a fall in the price level. Prior to World War II deflation was quite common in the United States but since World War II. inflation has been the norm. Prewar deflation took two forms. First, the price level might decline very sharply during an economic downturn.

Measuring Inflation

The measurement of the price level is a difficult task and, therefore, so is the measurement of the inflation rate. For example, many economists believe that the consumer price index has overstated the rate of inflation in recent decades because improvements in the quality of goods and services are not adequately reflected in the index. An index that held quality content, according to this view, would show a smaller rate of price increase from year to year, and thus a smaller average rate of inflation.

It is important to recognize that a positive rate of inflation, as measured by a price index, does not mean that all prices have increased by the same proportion. Some prices may rise relative to others. Some might even fall in absolute terms, and yet, on average, inflation is still positive.

When inflation is unexpected, however, it is entirely possible, almost inevitable-that real economic activity will be affected. Throughout American history there is evidence that money wages are “sticky” relative to prices; that is, changes in money wages lag behind (unexpected) changes in the price level.

Causes of Inflation

All of which begs the underlying question: What ultimately causes inflation (or deflation)? Although this is still a matter of dispute among economists in the details, most believe that inflation typically occurs when the supply of money increases more rapidly than the demand for money; or equivalent, when the supply of money per unit of output is increasing. This might occur within a single country; in a global economy, it can also spill over from one country to another.

The supply of money per unit of output can increase either because the “velocity” at which it circulates in the economy has increased or, holding velocity constant because the stock of money per unit of output has increased. The demand for money depends on the overall scale of economic activity, along with interest rates, which measure the opportunity cost of holding money balances. The supply of money depends on the so-called “monetary regime”the institutional framework by which money is created.

Inflation results from an increase in the amount of circulating currency beyond the needs of trade; an oversupply of currency is created, and, in accordance with the law of supply and demand, the value of money decreases. Deflation is brought about by the opposite condition. In the past, inflation was often due to a large influx of bullion, such as took place in Europe after the discovery of America and at the end of the 19th cent. When new supplies of gold were found and exploited in South Africa.

In modern times wars are the most common cause of inflation. as government borrowing, the increase in the money supply, and a diminished supply of consumer goods increase demand relative
to supply and thereby cause rising prices.

In mainstream economics. the word “inflation” refers to a general rise in prices measured against a standard level of purchasing power. Previously the term was used to refer to an increase in the money supply, which is now referred to as expansionary monetary policy or monetary inflation. Inflation is measured by comparing two sets of goods at two points in time and computing the increase in cost not reflected by an increase in quality.

There are, therefore, many measures of inflation depending on the specific circumstances. The most well-known is the CPI which measures consumer prices, and the GDP deflator, which measures inflation in the whole of the domestic economy.

The prevailing view in mainstream economics is that inflation is caused by the interaction of the supply of money with output and interest rates. Mainstream economist views can be broadly divided into two camps: the “monetarists” who believe that monetary effects dominate all others in setting the rate of inflation, and the “Keynesians” who believe that the interaction of money, interest, and output dominate over other effects. Other theories, such as those of the Austrian school of economics, believe that inflation of overall prices is a result of an increase in the supply of money by central banking authorities.

Problems Due to Inflation

If inflation is high in an economy there are three main problems it can cause:

1. People on a fixed income will be worse off in real terms due to higher prices and equal income as before; this will lead to a reduction in the purchasing power of their income.

2. Rising inflation can encourage trade unions to demand higher wages. This can cause a wage spiral. Also if strikes occur in an important industry which has a comparative advantage the nation may see a decrease in productivity and suffer.

3. If inflation is relatively higher in one country, and that country maintains fixed exchange rates with other countries, then the country’s exports will become more expensive for other countries to purchase, creating a deficit on its current account.

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