Essay On Inflation In Pakistan

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The overall general upward price movement of goods and services in an economy, usually as measured by the Consumer Price Index and the Producer Price Index. Over time, as the cost of goods and services increase, the value of a dollar is going to fall because a person won't be able to purchase as much with that dollar as he/she previously could. While the annual rate of inflation has fluctuated greatly over the last half century, ranging from nearly zero inflation to 23% inflation, the Fed actively tries to maintain a specific rate of inflation, which is usually 2-3% but can vary depending on circumstances.

Opposite of deflation inflation is a broad increase in prices. In practical terms, inflation means goods and services are being valued as more desirable than money. This also affects wages; periods of high inflation tend to be marked by increases in average income. Inflation can be caused by either too few goods offered for sale, or too much money in circulation. The most common measure of inflation is the consumer price index (CPI). Prior to Bretton Woods and the elimination of the gold standard, persistent inflation was relatively rare. In the US, for example, inflation for the entire period from Revolution through to 1914 was four percent. The move from currencies backed by hard assets to floating currencies backed by the "full faith and credit" of governments has nearly eliminated deflation by removing impediments to printing more currency. Consequently, excessive inflation has become the primary concern of central banks.

Causes of inflation

Inflation refers to a rise in prices that causes the purchasing power of a nation to fall. Inflation is a normal economic development as long as the annual percentage remains low; once the percentage rises over a pre-determined level, it is considered an inflation crisis.

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. As a result, prices end up rising at an extremely high speed to keep up with the currency surplus. This is called the demand-pull, in which prices are forced upwards because of a high demand.

Another common cause 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, which in turn leads to the company increasing prices to maintain steady profits. Rising labor costs can also lead to inflation. As workers demand wage increases, companies usually chose to pass on those costs to their customers.

Inflation can also be caused by international lending and national debts. As nations borrow money, they have to deal with interests, which in the end cause prices to rise as a way of keeping up with their debts. A deep drop of the exchange rate can also result in inflation, as governments will have to deal with differences in the import/export level.

Finally, inflation can be caused by federal taxes put on consumer products such as cigarettes or fuel. As the taxes rise, suppliers often pass on the burden to the consumer; the catch, however, is that once prices have increased, they rarely go back, even if the taxes are later reduced. Wars are often cause for inflation, as governments must both recoup the money spent and repay the funds borrowed from the central bank. War often affects everything from international trading to labor costs to product demand, so in the end it always produces a rise in prices.

There is only one cause of inflation and everything else happens as a result of that one major cause. In other words, everything else that happens becomes inflationary but not the cause of inflation. Rising prices are inflationary for sure but not the cause of inflation. Only the manufacture of more money than the total available yesterday causes inflation. Rising prices are a reaction to this extra money in the system. Manufacturing money out of thin air eventually puts more money in the ordinary person's pocket yet this endless production of extra paper money...done by the central banks, does not require any extra effort on behalf of the worker so he ends up with more money in his pocket to buy "things" at no extra cost to him. That sounds nice but with more money to buy things, the money becomes worth less and to compensate.... the "things" go up in price or else they would become cheaper for no real reason. The value of money is determined by dividing the number of "things" available by the total amount of money available. As the amount of money available increases, the value of "things" would go down if the system did not compensate by putting the value of those "things" up....hence an inflationary reaction to the extra amount of money available. This is not a complicated operation but rather hard to explain when money and the value of money are talked about. The value of money is different than the total amount of money available. The value of money rises or falls with the total amount of money available. If the central bank manufactures, out of thin air, more money than yesterday's total, then the value of money would go down...which would be seen as prices of "things" going up to compensate for the extra amount of money available.

Inflation can be caused by federal taxes put on consumer products such as cigarettes or fuel. As the taxes rise, suppliers often pass on the burden to the consumer; the catch, however, is that once prices have increased, they rarely go back, even if the taxes are later reduced.

"...Manufacturing money out of thin air eventually puts more money in the ordinary person's pocket yet this endless production of extra paper money...done by the central banks, does not require any extra effort on behalf of the worker so he ends up with more money in his pocket to buy "things" at no extra cost to him. That sounds nice but with more money to buy things, the money becomes worth less and to compensate..."

Manufacturing money out of thin air...is the only way to do it because money is abstraction like number. The major problem with money is who should issue it! *Not* any bank or any government but the buyer who is also the seller of goods or service. Inflation is only caused by the growing cost of raw materials caused by growing interest to borrow money. The increasing amount of money on the market does not cause inflation!

The moment someone says we need more money to do trade; bankers and economists are using this purely theoretical inflation formula to scare public and that is why they get away with so call tight budget that is causing recession, endless bankruptcies and homes foreclosure. Remember we do not know how many things are available and total amount of money available. Bankers pretend to know and use it to their advantage.

Cost-Push Inflation vs. Demand-Pull Inflation

The first is "supply-shock" inflation. That happens when oil prices go up, because a company selling you, say, plastic storage containers must pay more for the oil it needs to make the plastic, heat its factory, run its machines and fill up its trucks. The company must then pass along those higher costs to consumers through higher prices. (Incidentally, Rubbermaid has just sharply raised the prices of its storage containers, citing a 60 per cent increase in resin costs.) This often leads to "stagflation," where you have a stagnating economy as prices soar.

Then there's "demand-pull" inflation, which you get when your economy overheats and workers are in short supply. This more dangerous and entrenched form of inflation pushes up wages and other business costs, which pushes up prices. "It's like if you want to get a deck built at your house right when everyone else is getting a deck built," Ragan says. "You have to wait longer, and you have to pay more."

Supply-side inflation, due to a leftward shift in aggregate supply, is a different story, as the shift has caused the economy to be below potential (that is, slow economic growth or a recession). The Fed has three options here - First,it could cut the money supply, which eliminates the inflation problem but causes the economy to get worst. Second, it could increase the money supply, which benefits the economy but makes the inflation problem worse. Or it can do nothing and let the economy get back to equilibrium on its own.

INTRODUCTION

Inflation seems to be a chronic problem in many parts of the world today and unemployment, a phenomenon, true for Pakistan, and valid for United States and other western economies. Even the fastest growing Chinese economy is not totally immune to it. Thus this research project

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deals with the analysis of unemployment and inflation in Pakistan. The purpose of this research is to analyze the relationship that exists between these two macroeconomic variables, which affect every nation as well as an individual.

The Phillips curve shows a historical inverse relation between the rate of unemployment and the rate of inflation in an economy. It is the trade-off between inflation and unemployment (Mankiw, 2002). The lower the unemployment in an economy, the higher the rate of change in wages paid to labor in that economy.

LITERATURE REVIEW

The relationship between unemployment and inflation the two macroeconomic variables is usually summarized by the Phillips curve. Different studies have been conducted related to these variables in order to see whether any relationship between these two macroeconomic variables exists or not. While analyzing the trade-off between inflation and unemployment in Asia, (Dua 1996), takes inflation as the function of expected inflation, unemployment gap/ output gap, exchange rate, import inflation and oil price inflation. In India and Philippines the tradeoff between inflation and unemployment does not exist, whereas, in Japan, Korea, Singapore, and Hong Kong it does. (Rafael, MacCulloch, & Oswald 2000), on the other hand, suggest that welfare and life satisfaction level is a function of inflation and unemployment and people are happier when rates of both are low.

However unemployment in comparison with inflation depresses people more than inflation. Thus while controlling country fixed-effects, year effects, and time trends, it is estimated that people will trade 1% increase in unemployment for 1.7% increase in inflation. A strong positive relation between unemployment rate and inflation rate lagged one or two years is also shown, which is inconsistent with both Philips curve and NAIRU. In other words the trade-off between inflation and unemployment rate does not exist,

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except in the same year, and in the long run unemployment is a positive function with inflation (Niskanen 2002). Namibia, using the time series data from 1991-2005, exhibits the presence of stagflation in its economy.

In other words he found increase in both inflation and unemployment at the same time, which contradicts the traditional short-run Philips curve (Ogbokor 2005). (Furuoka 2007) using the data of Malaysia from 1975-2004 shows and existence of co-integrated as well as casual relationship between inflation and unemployment. That is the study provides an empirical evidence to support the Philips curve.

Likewise, Philips curve also exists in Japan, with negative coefficients of linear link between inflation and unemployment. Also there is a generalized linear and lagged relationship between labor force, unemployment and inflation in Japan, which is confirmed by the fact that the driving force behind unemployment and inflation is the change rate of labor force level (Kitov 2007). In this paper, a Philips curve with linear link will be calculated for Pakistan to see if the negative relationship between the variables exists or not.

Problem Statement:
What is the likely relationship between inflation and unemployment in Pakistan? Hypothesis:
If unemployment increases, then inflation decreases.

Data Source:
Secondary data for the purpose of this research has been obtained from the year 2000-2011. The data on unemployment rate (percentage of total labor force) and inflation rate (general not adjusted for food and energy) for Pakistan, has been taken from the Economic Survey of Pakistan.

Objective

The objective of this research is to determine the relationship between inflation and unemployment for the economy of Pakistan. Philips curve is based on the equation where unemployment is the function of inflation.

METHODOLOGY

Here, a regression is run for inflation rate and unemployment rate for Pakistan. The functional form of the model which is as follows: Y = βο + β1X1 + Є

Substituting the above inflation function in the equation
INFt = βο + β1Ut + Єt
Where U is the unemployment rate and INF is inflation rate for a given time “t”. The Equation obtained after running the OLS model is:
INFt = 30.96981 – 3.306067 Ut

Dependent Variable: INF

Method: Least Squares

Date: 08/01/13 Time: 21:49

Sample: 1 12

Included observations: 12

Variable
Coefficient
Std. Error
t-Statistic
Prob.

C
30.96981
6.078158
5.095263
0.0005
U
-3.306067
0.882942
-3.744377
0.0038

R-squared
0.583686
Mean dependent var
8.549167
Adjusted R-squared
0.542055
S.D. dependent var
5.344512
S.E. of regression
3.616718
Akaike info criterion
5.560023
Sum squared resid
130.8065
Schwarz criterion
5.640841
Log likelihood
-31.36014
Hannan-Quinn criter.
5.530101
F-statistic
14.02036
Durbin-Watson stat
2.038825
Prob(F-statistic)
0.003819

While interpreting the regression line, the negative sign with the coefficient of unemployment shows that in Pakistan Inflation and unemployment are inversely related at “t” period. One percent increase in unemployment in one year will bring a decrease in inflation of 3.306067 percent. Unemployment in this simple regression model is statistically significant as the probability of t-stats is less than 0.05 and so we reject H0. The intercepted value 30.96981 of B0 shows the inflation rate when unemployment is zero. The R2 for this model, which lies between 0 and 1, comes out to be 0.583686 which shows that 58.36 percent of the variation in inflation is explained by unemployment.

The adjusted R2 statistics comes out to be 0.542055. The Durbin-Watson d statistics test, which is done for autocorrelation, is 2.038825 for Pakistan, showing that there is no auto or serial correlation. As this is simple regression model multicollinearity is not present. As the probability of F-stat is less than 0.05 we will reject H0 which means that the model is overall statistically significant. The Scatter Plot for Inflation and Unemployment somehow depicts the same relationship as above.

CONCLUSION & RECOMMENDATION

This study is conducted in order to make an analysis of inflation and unemployment in Pakistan from year 2000-2010. It has employed a simple regression analysis technique. The main conclusion derived from this study is that the tradeoff between these two variables, the Philips Curve, is observed in Pakistan. When unemployment is high, the cost of goods will increase during an inflationary period, but firms will be able to hire cheap labor, as labor will be in surplus.

Wages will not rise while unemployment remains high. Workers will have to borrow money or reduce the amount of goods they purchase. If workers cannot get loans, firms will have to lower prices to continue to sell products, thus reducing inflation. This study makes the following recommendation in the light of its analysis. Easy fiscal policy can be used to decrease unemployment at the expense of inflation, as mild inflation is desirable in every economy. However in Pakistan the inflation rate is much higher than the unemployment rate. Thus Pakistan has to focus more on policies which lead to reduction in inflation but the Government should also control unemployment at the same time.

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