Rise in the prices of goods
Inflation is the rise in the prices of goods and services over a period of time in an economy. When the general price level rises, each unit of the currency buys fewer goods and services; consequently, inflation is a decline of purchasing power in the internal medium of exchange, which can also be rephrased as a decline in the real value of money i.e. the monetary unit of account in an economy. Inflation is a key indicator of a country’s economy and provides important insight on the state of the economy and the macroeconomic policies that govern it.
There are many causes of inflation, for example, inflation can happen when governments print an excess of money to deal with a crisis. As a result, prices rise at an extremely high speed to keep up with the currency surplus. All the sectors in the economy seek to buy extra than the economy can produce. Shortages are thus created and merchants lose business. To balance, some merchants raise their prices. Others don’t offer discounts or sales. And thus, the price level rises. This is called demand-pull inflation, in which high demand forces the prices upward.
Another common reason of inflation is increased production costs, which leads to an increase in final product cost. If raw materials increase in price, this leads to the increased cost of production, this in turn leads to the increasing prices by company to maintain their profits, this kind of inflation is call cost-push inflation.
Inflation is also caused by a deep drop of the exchange rate, as governments will have to deal with difference in the import & export level. Economic recessions largely appear after oil price occurrence. Particularly, the global inflationary pressures of 2008 became severe with the ever increasing oil prices as well as crop productivity shocks in the world economy including Pakistan.
Oil prices in terms of domestic currency highlight the fact that world shocks because of exchange rate fluctuations leaves significant impacts upon domestic inflation.
Pakistan, an oil importing country with a significant low economic growth and a depreciating exchange rate is facing a lot of challenges with the ever growing international oil prices. One of the most significant and direct impact of the same can be read through our country’s growing inflation. International oil prices aside the inflation in our country is also an affect of the frequent changes in the government, inconsistent policies and other dramatic political and economic developments that put upward pressure on prices.
The relationship between growth and inflation depends on the state of the economy. Maintaining high growth, without increasing inflation, is possible if the productive capacity of the economy is growing with the demand pace. It’s also possible if the actual output is below the potential output and there is sufficient capability available to meet the demand pressures. When the actual output meets the potential output, there is no spare capacity and the economy is at its full employment level, any further growth comes at the cost of increased inflation. At this stage, if the productive capacity does not increase, there is an intimidation of rapid inflation in the long run; in such a case inflation can have severe consequences for the economy.
People expect higher salaries to pay off for expected increase in prices, assumptions in asset prices increases, manufacturing sector credit diverts to real estate and stock markets, and hoarders, profit and rent seekers become vigorous in expectation of higher price in the future. All this can have devastating effect for the prices, ruining the economy and worsening the inflation.
LITERATURE REVIEW Economy of Pakistan had a low inflation trend for the last couple of years however over the last three years it has shown a rising drift. One of the major hurt to our economy is from the rising international oil prices. This hit to our economy is because of our dependency on oil from international market. There are other several internal and external factors which attributed to the recent rise. Major factors include: sharp economic recovery bringing in rise in the levels of economy with a significant flow in domestic demand; with the continual effect of international oil prices and a spontaneous effect of commodity price increase. (Hamilton 2009).
For the last five years when oil prices have been rising, Pakistan’s economy has shown a rising trend showing a substantial increase in demand of oil, resulting in squeezed income and demand. Over it our depreciating exchange rate has not been favourable to the economy, domestic currency depreciation has resulted in increased payment for the same output of oil imports. This chain further leads to cuts in purchasing power of imported goods. The macroeconomic performance is also affected through the high costs of production, resulting in reduced output. This way the domestic supply channel exerts an inflationary pressure on the economy, thus directly raising the consumer prices through higher prices of imported goods and petroleum products.
Cpi Trend To Get From Board Of Investment
The measure of inflation that is used in inflation targeting can be defined as core or headline inflation. By meaning, ‘core inflation’ excludes items of unstable price movements from the CPI, thus eliminating the temporary effect of price shocks and focuses on long-term price changes. Core inflation should be a good meter to underlying long-term inflation trend, and it provide an indication of future inflation. The core inflation should also be capable to find the components of overall price changes which are predictable to continue in the long run. This helps policy makers to use this information for short to long-term inflation prediction. ‘Headline inflation’, however, looks at the rate of change in the average price of a basket of goods, consumer price index and services (Khalid, 2005). The economy of Pakistan is affected adversely due to ever increasing international oil prices. The most affected countries are the ones which are highly inclined and dependent on energy Shiu-Sheng Chen (). This then leads to an increase in transportation costs and energy intensive industry products like metal commodities. Producers tend to impart the increased costs to consumers consequential to higher inflation.
The general domestic prices also rise in response to increase in international oil prices. However, these increased prices are not brought down as the oil prices decline. (Hamilton 2009). Macroeconomic variables have a larger and longer-lived oil price shocks effect such as output growth, the aggregate price level, and inventory investment. (Herrera and Pesavento) (Oil price pass-through into inflation, Shiu-Sheng Chen) Increasing oil prices affect the economy from two different channels; the demand side and supply side. Surging global demand and the failure of global supply to keep pace has generated persistent upward price pressures (Inflation in developing Asia, Juthathip Jongwanich). Supply side is affected the most because of the high oil demand resulting in increased production costs. Given a swap in production factors comparative price changes results in reallocation of means of production. The external cost-push factors especially oil prices appear to be more important in explaining producer price inflation than consumer price inflation. Oil prices are equally important in producer price inflation. In PRC; India; Philippines and Thailand inflationary expectations, measured by the delayed producer price inflation, explains much of the producer price inflation variance. They account for more than 50% in the Philippines and Thailand and around 45% for the PRC and India. Oil prices are more significant than food prices in explaining the variation in consumer price inflation. About 20% of the variation in consumer prices is explained by oil prices (Inflation in developing Asia, Juthathip Jongwanich). The real investment impact is fundamentally on the prospect of the stability of oil prices changes, which in case of international oil prices tend to change over time. Looking over the demand outlook the general level of prices drive up as a result of oil price shock resulting in a lower disposable income and reduced demand (Schneider 2008).
It is functional to differentiate between cost-push and demand-pull drivers of inflation. The central cost-push factors are international oil and food prices, while the main demand-pull factors are surplus aggregate demand, accompanied by the output gap, and inflationary anticipations, which are a function of delayed inflation. Whether inflation is the cost-push or demand-pull, it has reflective proposition for monetary policy. If inflation is driven by the rising input costs (cost-push inflation) of goods and services – a noticeable slowdown and increasing unemployment is likely to go together with higher inflation. Tightening monetary policy would come at an abrupt cost in terms of slower growth and higher unemployment. Temporarily, loosening monetary policy in return to declining global oil and food prices would not be important in pushing up employment and boosting economic growth. On the contrary, monetary policy would be more effective in controlling inflation if inflation was the demand-pull. In this case, tightening (loosening) monetary policy would dampen (boost) aggregate demand (Inflation in developing Asia, Juthathip Jongwanich).
During period of high fuel and food prices, currency appreciation limits the move across of these prices into domestic prices. In view of the reality that the global financial crises are intensifying, regional currencies in developing countries have generally depreciated, Pakistan being no exception. (Inflation in developing Asia, Juthathip Jongwanich). Oil prices directly effect the general price level, resulting in higher wage pressures and lower demand dampens employment. We say our economy is hit by the change in international environment due to increased oil prices. Economic growth has thus replaced inflation as the main macroeconomic apprehension for policymakers. Conversely, monetary policy could play an important role when inflationary expectations are taken into account, in holding inflationary pressure or in defusing deflation, despite the source of the shock. Monetary policy’s effectiveness would be more imperfect if the sources of inflation are primarily external cost-push factors rather than demand-pull factors which can also cause inflation expectations. In this ongoing global slackening, the central banks of both developed and developing countries are loosening monetary policy to boost domestic demand, and also to smooth out the risk of deflation. In short, breakdown of inflation into its sources would help monetary authorities to spot appropriate monetary policy responses.
In Pakistan, excess aggregate demand and inflationary expectations are more important, this has reflective implications for monetary policy for the country. Particularly, it means that monetary tightening will continue to be a controlling tool for fighting inflation in the future. Higher interest rates can exercise their usual anti-inflationary effect by bringing down demand. Pre-emptive and decisive tightening of monetary policy can strengthen the case for firmly securing inflationary expectations for the country. Though, implementing monetary policy is inherently complicated and forward-looking in nature (Inflation in developing Asia, Juthathip Jongwanich). Goodwin (2007) claims that increasing oil prices lead to reallocation of resources from energy intensive to energy-efficient sectors. This reallocation advancement is slow, resulting in short-term decline in output results which increases the economic slowdown. When oil prices reduce, the resultant expansion of aggregate output is dampened by adjustment costs. In this association, the adjustment costs impact is important on the labor market. Thus, employees will try to negotiate their wage hikes to compensate the loss of purchasing power. Oil shocks are the classic supply shock in traditional macroeconomic models. Labor becomes expensive in all sectors as workers try to adjust their inflation prospect. Margins fall throughout the economy, and cumulative supply contracts, pushing prices upward. (Another Pass-through Bites the Dust? Oil Prices and Inflation Óscar Landerretche) Adding up to the inflation expectations and worsening the economy.