Inflation
Inflation:
We heard the term "Inflation" many times and instantly consider it a hike in the price of goods and services available in any economy. Or once we experience an increase in the price of any commodity compared to the last purchases, we normally call "Oh! its expensive now". Does it mean all about inflation?
To some extent it is correct, let us discuss this topic in a simple manner.
What is Inflation:
Inflation is a consequence on price due to change in either cost or demand and supply of goods and services available in the economy. where cost we means the value which is denominated in the local or international currency, and demand/supply is the available quantity of those goods and services in the economy.
Now the question that appears is, could it be possible to have a decreasing effect on any price of goods and services due to demand and supply change?
Yes, like excess supplies of seasonal crops, out of season products available in the market, excessive local levies etc.
Below are some factors for consideration to enhence this discussion.
i) Due to decrease in demand of any commodity; the price will fall and vice versa.
ii) Increase in supply of any commodity, price will fall and vice versa.
iii)Decrease in the purchasing power of people.
iv) Increase in the rate of direct taxes.
v) Changes in the interest rates
vi) Changes in the money supply, means circulation of currency notes
vii) Changes in rate of services or wages.
viii) Currency parity appreciation or devaluation.
Inflation and Fundamental Economic laws:
Now, we extend our discussion to some fundamental economics laws. These are the laws of demand and supply. Law of demand says, if the demand increases for any goods or services, its price increases, whereas, increase in supply have an inverse effect of the price of any particular goods or service.
But the limitation of these laws is basic assumption, that the other factors in the economy remains the same or non responsive to bring any change in price and quantity.
Now, we take a look of different types of inflation during 2019 in prominent countries of the world.
Summary:1
| Inflation Type | ||||||
| Region | Low | Medium | High | Hyper | Reverse | Zero rated |
| Below2% | Below5% | 10-20% | 50% or above | Below 0% | NIL | |
| Asia | Japan, Israel,Kuwait | China, India, Hongkong | Turkey, Pakistan | Iran, North Korea | Saudi Arabia,UAE | South Korea |
| Thailand | Indonesia | Uzbekistan | Bahrain,Qatar, Brunie | |||
| Europe | Belgium,France, UK | Russia and Romania | Nil | Greece | ||
| Germany, Italy, Norway | ||||||
| Americas and Carribean | USA, Canada and Chile | Brazil, Columbia and Mexico | Haiti | Argentina | ||
| Africa | South Africa | Nigeria, Ethiopia | South Sudan | |||
| Australia | Australia, Newzeland | |||||
Summary:2
   G20 means group of twenty countries of the world having most developed economic model and participate in more than 80% of the economic activities of the world.And other means Non G20 countries which also play significant part in world economy. G20 countries are:
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From the above details, we can find out that both G20 and other countries fall under each type of inflation group.
Two G20 countries, Turkey and Argentina fall under high and hyper inflationery slab.
Further, two other G20 countries, South Korea and Greece(EU) fall under Nil inflation slab.
Further, Venezuela and Zimbabwe are two countries where the inflation rate was reported as 283,000% and 176% which is totally insane. Which means the economy of these two countries cannot be comparable under the extinging economic indicators.Will discuss this topic later.
How we calculate inflation in any economy:
For calculation of inflation we need two prices; current price and base price of the commodity.
The current price is the latest dated price and the base price is the old price of any year of the same commodity. Normally inflation is calculated on real time basis and used in reference to complete year to year basis like, current year vs previous year. Or instead of previous year we can assume any other past year based on accuracy of data and considering it equal to 100 base.
Like: Petrol price per litre 2020 is USD $0.6, 2019 it was USD$ 0.55, so the inflation rate of petrol is 9.09% (0.6/0.55).
But now the question appears, do we need to calculate inflation for each goods and services seperately?
If so it will be very difficult to monitor this data.
The economist tried to simplify this issue by using below three components which are essential in the calculation of inflation.
1.The core Inflation; this includes changes in the prices of all goods and services other than food and energy products.
2.The calculation above is based on consumer price Index (CPI), whereas the CPI is monitoring tool where we examine the weighted average prices of basket of goods and services on monthly and yearly basis.
What is basket of goods and services?
It is all types of goods and services which are produced in the economy and their prices are monitored constantly.
3.The Non core inflation is based on basket of food and energy goods for seperate calculation.
Why Non core Inflation is calculated seperately:
As per expert economists, the food and energy item's prices changes more frequently than others, and the laws of demand and supply is termed as inelastic under these items specifically in the context of consumer or ultimate user. So, in order to have 3D image of inflation, it is better to calculate non cure inflation seperately.
The inelastic is a economic term which says that price does not change due to rise and fall in demand and supply. Like food is necessary for human life, the increase in price will not decrease the real consumption, but rather there will be a shift towards alternate food item available in the market, but overall the demand will remain the same; it means if beef prices go up, the demand will shift to chicken or vegetable but the overall impact will remain same in the food item basket.
The group of Exceptional Countries-0% Inflation
1.South Korea and Greece are two countries where the inflation rate was zero in 2019. Greece is EU based small economy but it is least important to discuss here in the context of 0 % inflation rate due to the reason below:
a) During 2019 its nominal GDP was USD $ 214 billion and stood at 50th number among global economies.
b)Greece is still under recession after the EU bailed out step happened in June 2013 by Euro 110 billion.
South Korea is an important country, having a nominal GDP during 2019 USD $ 1.6 trillion and 12th top economy in the world. Below are some of the reasons of 0% inflation here.
a) Its is still fastest growing economy among all developed countries
b) It has a medium population of 51 million and labour force of 28 million, means half of the population involves in economic activities, which is very appropriate ratio.
c) Although the rate of unemployment is around 4% here, but due to available basis social security system, the individual buying power of citizen remain unchanged.
d) It has narrow money (M1) circulation about USD$ 742 billion as per 2017 CIA fact book data base and ranked at 9th place.
e) Industry production growth rate was 4.6% during 2017.
Further,there is a group of countries fall under reverse or below 0% slab, these are mostly OPEC members, having a fixed product based economy either oil or gas. Their population are small and most of the economic activities are dominated by State spending and by changing the local levies for state welfare. These are absolute monarchies, and responded very well in the precautionery measures during peak Covid 19 period earlier 2020.
The group of Exceptional Countries- More than 100% inflation rate
As discussed earlier, Zibabwe and Venezuela are two countries having insane inflation rate of 100% plus. But if we see the economic and political situations here below are the important factors.
a) Social imbalance among people, corruption and lack of local production of goods in major areas.
b) Political boycott from World union like UNO.
c) Since due to trade embargo, Venezuela is not allow to sell oil in international market, even she is a OPEC member.
d) The local economy is not self sufficient in the basic goods manufacturing.
e)People stop in trusting local currency, like in Zibabwe, USD$ is prefered currency.
Is Inflation is a economic problem or Political Stigma?
Inflation is a composition of both elements.
In case of Venezuela, Iran and North Korea, its a Political stigma, inspite of strong local economies these countries find hard to minimize inflation rate due to global trade embargo.
There are other two groups of countries where inflation rate are kept in the level of global trade favour instead of its local economic benefits.
1.Countries with huge natural resources, which are essential for the world, here the local currency is pegged with any strong international currency backed by commodity exports volume.
2.Countries, which are huge in market and can attract global economy, have normally moderate inflation rate.
Inflation and Money Supply:
Money supply means how the local currency notes are physically available and the money available in the current accounts/demand deposit account and time deposit accounts in the local bank accounts.
We will discuss this topic by below example of Pakistan.
| Currency in Circulation Pakistan | |||||||||
| As per SBP annual report -Statistical supplement FY19 (5.2) | |||||||||
| Amount in USD million) | $ rate 167.5 | ||||||||
| YEAR | TOTAL | HELD BY SBP | HELD BY COMMERCIAL BANKS | CASH IN CIRCULATION | % of CASH IN CIRCULATION | ||||
| 2015 | 16,212 | 3 | 957 | 15,252 | 94 | ||||
| 2016 | 21,276 | 4 | 1,369 | 19,903 | 94 | ||||
| 2017 | 24,937 | 6 | 1,580 | 23,351 | 94 | ||||
| 2018 | 27,731 | 7 | 1,528 | 26,196 | 94 | ||||
| 2019 | 31,610 | 7 | 2,051 | 29,552 | 93 | ||||
Kindly note these are most appropriate numbers as per State bank of Pakistan subjec to below considerations:
1.Since State bank is the currency note issuing authority, the total number of currency notes issued from SBP are considered here in order to work out the estimated actual cash circulation in the economy.
2.There could be some lost or mutilated currency notes, which appears in the above circulation value, but in actual these are not part of circulation.
3.There are some Non active or dormant bank account, which are also included in the above summary.
4.Local currency held by non residents abroad and appear in above currency circulation volume, like international exchange companies outside Pakistan etc.
5.Provision of fake currency notes under circulation while not apearing in the above currency volume.
6.There are some countries where Pakistani currency is widely accepted like Afghanistan, Tajikistan etc, so these volume may also appear here in the cash circulation numbers.
7.There are chances that cash in circulation volume eventually converted in another currency from the kerb market and already moved out of local real circulation.
Reason of Inflation in Pakistan:
Pakistan falls in the group of double digit inflation countries. There are 17 countries in this category, some other important countries are; Turkey, Iran, Nigeria, Argentina, North Korea, Sudan,Ethiopia, Uzbekistan,Mayanmar and Yemen.
Below are some prime reasons of inflation in Pakistan.
1. The availablity of actual economic data is difficult. The the private market research data collected by private sector still not appropriate to real economic transactions.
2.Due to above reason around 32% of Pakistan economy is considered as undocumented or shadow economy.
There are many G20 countries which also fall under this category like;Brazil 35%. Russia 34%, Venezuela 34%, Cyprus (EU) 32%, Mexico 28%, Turkey 27%, Greece 26%, Argentina 25%, Italy 23%, Spain 22%, South Africa 22%, Indonesia 22%, Bulgharia 21%, South Korea 20%, India 18%,Saudi Arabia 15%, China 12%, France 12%, Canada 9%, UK 8%, Japan 8%, Australia 8%, Germany 8% and USA 7%. These are huge economies and even then have undocumented economic data, which will by far more than the whole undocumented data of non G20 countries.
3.There is lack of value addition facilities and conversion of value addition into extended use for a longer period of live, like live stock, vegetables, fruits and dairy products etc.
4. As per SBP report above, around 93% of narrow money (M1) is dominated by cash currency notes, for which we can not estimate the intended use.As a result it gives rise to credit creation in banking channel and the money supply in the economy.
5.The rise in State functioning cost and decrease in the public welfare expenses. The basic infra structure of health, eduction, security, power and water are not sufficient hence people has to opt the private sector products to fulfill their consumption need, and it cause rise in inflation.
6.Currency devaluation creates artificial windfall benefits for the exports, but it increase the import bills, and if the country economy is dominated by imports, it will apear a cost pull inflation view in the economy.
7.Interest rate mechanism, ideally the decrease in central bank interest rate cause inflation in the economy and high interest rate causes decrease in inflation rate. But this theory is getting obsolete like we have examples of Japan, Switzerland and Denmark with negative interest rates (only for domestic debtors) and fall under low inflation countries. Like wise there are some countries with high Central bank interest rates but their economy fall under high inflation rate category, like Iran, Nigeria and Pakistan.
With reference to Pakistan even due to higher interest rate there is insignificant effect on inflation as volume of cash circulation in the market is 93%.
8. The unemployment rate is 5.8% in Pakistan and lack of State basic infra structure it give rise to non core inflation.
9. The execessive local levy structure.
10. Lack of local manufacturing facilities.
How to minimize Inflation in any economy:
1.Mandatory decrease in cash transaction by law.
2.Intruduction of banking by non banking institution like, Post office, railways, utilitities services providing companies.
3.Develop a culture of doing self business.
4.Rural development. The rate of inflation in rural areas was recorded higher than urban areas.
5.Small scale industry setup.
6.focus on under utilized or non utilized natural assets accross the country, like land, building, water resources etc.
7.Promotion in agri based industries with developed scientific technologies.
8.To setup technical training centres in small towns and rural areas for skill development of people.
9. Develop warehousing facilities.
10.Increase in better transport network.
Infact, the Inflation is related to many other economic and social factors of economy and society as a whole.
I tried to present this article for the general understanding of all readers, without using complex specific economics terminologies.
Now, reader will give me the feedback about this article. Will appreciate your vital comments and views.
Special thanks for google image search engine for adding some relavant snaps for the interest of my kind readers.
Stay Blessed.
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