INFLATION is one of the determinants of macro-economic stability, the recent evidences suggest that long-term economic growth requires macroeconomic stability. Low inflation along with sustainable budget deficits, realistic exchange rates and appropriate real interest rates are the indicators of stable macro-economic environment. So the rate of the inflation assumes enormous significance in the economic performance.
In our case, inflation is mounting to irritating level and has touched seven-years’ high figure of 9.95 per cent increase in February last. But in March it even surpassed the previous highest figure and increased by 10.25 per cent over the same period of the last year. The international financial institutions have cautioned the government to contain inflation otherwise it will have serious implications for the current momentum of growth.
Inflation is a multidimensional phenomenon and there are diverse outlooks about its cause and effect. The monetarist model asserts that the prime factor explaining the current rate of secular price is change in the past behaviour of money to out put ratio. This is also dictum of the quantity theory of money which regards inflation as a monetary phenomenon.
The cyclical position of the economy also affects inflation. If the growth is in excess of the economy potential, factors of production will have to be utilized intensively putting pressure on wages and prices. It has also been argued that the third world economies with rapidly growing manufacturing sector when encountered with supply rigidities, especially from agriculture sector can produce incessant rise in relative prices in the absence of corresponding increase in agricultural products.
Such sectoral increase in relative prices due to resulting structural rigidities may easily be translated into a rising general price level, thus producing high inflation. Developing countries in their bid to raise the standard of living of their people through development plans have often found themselves in the grip of inflation.
However, the recent inflation, is creeping up due to easy money policy. Negative interest rates means that the interest rates are lower than inflation rates. These negative interest rates encourage speculative activities that generate maximum profit in the short run, for instance, investment in real estate and stock exchange, hoarding of some necessary food items like wheat and sugar.
Low interest rates are the outcome of surplus liquidity. Surplus liquidity is the gift of post 9/11 events—prize money won as a frontline state in war against terrorism, increased flow of foreign remittances by frightened Pakistanis abroad and flow of foreign aid from United States of America and European countries.
Increase in the prices of petroleum products and food items also pushed up month-on-month inflation and both— food and fuel— inflation are likely to move further up in the remaining part of the year.
Food prices that account for 40 per cent of CPI inflation are escalating despite import of more than a million tons of wheat. Sugar prices are also shooting up forcing the government to allow import of raw and refined sugar. Another cause of demand pull inflation in the current year is that strong economic growth (5.1 and 6.4 per cent) in the last two years has given rise to the domestic demand.
The State Bank is equally responsible for allowing inflation to rise so sharply because it continued with a lax monetary policy for too long and started tightening it too late and too slowly.
On the effects of the inflation, there are varied judgments. In some cases, inflation seems justified as a lubricant to economic growth. In other cases, it appears that rampant inflation has disrupted the economy and retarded economic development. The record suggests that inflation may be either a good or a bad thing, depending on the way in which inflation is generated and what other things are happening at the similar time.
Inflation that is the result of successful execution of a large volume of development investment may be worthwhile, but if the same is produced by deficit financing of current expenditures or careless extension of bank credit, it is likely to hamper economic growth. The whole experience gives rise to considerable controversy about the relationship between inflation and economic growth.
But the economic irrationality of the recent surge in the inflation is because of careless extension of credit. It is hitting low and middle income groups especially salaried segment very hard and is likely to impede economic growth as well.
The present surge in inflation has prompted the State Bank to take effective countervailing measures to bring the inflation rate down to protect the economic growth rate.
The SBP has decided to decrease interest rate and has withdrawn Rs5.5 billion from the inter-bank market to tighten the on-going easy money policy. The appropriate policy for developing countries will be the same as that pursued by the belligerent countries during war, to undertake public investment and encourage private investment, needed to achieve the major objective and to use every possible means to mop up excess purchasing power when it appeared.
The following points can be instructive in this regard:
In a developing economy, the prices of essential commodities are the main determinants of inflation, which in turn are determined on the basis of supply and demand. Supply situation is influenced by factors like production and availability of the consumer food items, the seasonality factor, failure of crop etc. So government must bring about revolution in agriculture to reach at the stage of self-sufficiency at least in food crops.
The economic managers must tighten fiscal and monetary policy. Increase in credit to the private sector is alarming and close monitoring should be in place for ensuring its productive use.
Smuggling, hoarding and black-marketing should be checked at the at utmost speed, through strict measures in order to avoid supply shocks.
The decision to establish consumer councils at provincial should be materialized quickly. The government should enforce strict punitive measures against monopolies cartels and hoarders of commodities in different sectors.
In a nutshell, government must take notice of this abrupt surge in general price level otherwise economic evils will overshadow all other achievements in the macro-economic sector.
