The concept of inflation

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. Generally, the whole world is facing the problem of price hike, but in Pakistan it has become a severe one with more than 11% inflation rate per annum. Major cause of increase in the price level is an increase in currency or credit money. Increases in the quantity of money or in the overall money supply (or debasement of the means of exchange) have occurred in many different societies throughout history, changing with different forms of money used.

This practice would increase the money supply but at the same time the relative value would be lowered. As the relative value becomes less, consumers would need to pay more money in exchange for the same goods and services as before. The effect of inflation is not distributed evenly in the economy, and as a consequence there are hidden costs to some and benefits to others from this decrease in the purchasing power of money.

Increases in the price level (inflation) erode the real value of money (the functional currency) and other items with an underlying monetary nature (e.g., loans and bonds).

High or unpredictable inflation rates are regarded as harmful to an overall economy. They add inefficiencies in the market, and make it difficult for companies to budget or plan long-term. Inflation can act as a drag on productivity as companies are forced to shift resources away from products and services in order to focus on profit and losses from currency inflation.

And inflation can impose hidden tax increases, as inflated earnings push taxpayers into higher income tax rates unless the tax brackets are indexed to inflation. Historically, a great deal of economic literature was concerned with the question of what causes inflation and what effect it has. There were different schools of thought as to the causes of inflation. Most can be divided into two broad areas: quality theories of inflation and quantity theories of inflation.

The quality theory of inflation rests on the expectation of a seller accepting currency to be able to exchange that currency at a later time for goods that are desirable as a buyer. The quantity theory of inflation rests on the quantity equation of money that relates the money supply, its velocity, and the nominal value of exchanges.

Adam Smith and David Hume proposed a quantity theory of inflation for money, and a quality theory of inflation for production. There are many other reasons for inflation, like in Pakistan, export is less than import, loadshedding is also an account of inflation as factories cannot run without electricity, increase in currency or credit money and increase in stock of money, etc.

Today the primary tool for controlling inflation is monetary policy. Most central banks are tasked with keeping the federal funds lending rate at a low level, normally to a target rate around 2 percent to 3 percent per annum, and within a targeted low inflation range, somewhere from about 2 percent to 6 percent per annum.

A low positive inflation is usually targeted, as deflationary conditions are seen as dangerous for the health of the economy. Some other which should b taken to control inflation are: fixed exchange rates, gold standard, wage and price controls, cost-of-living allowance. The government must follow stringent monetary and fiscal policies.

MADIHA ASHRAF

Karachi