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Inflation is when the prices of goods and services rise across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services and bills—Tax Foundation, USA.
Inflation, a widespread economic phenomenon, signifies decline in the purchasing power of money, affecting governments, businesses and individuals alike. Its broad consequences make it a central concern for policymakers worldwide. High or persistent inflation directly erodes purchasing power, diminishes investment returns and lowers living standards. This all-encompassing impact underscores the urgency of addressing inflation through effective policy measures.
Policymakers must prioritise strategies to mitigate the adverse effects of inflation on both businesses and individuals. When it persists, inflation poses significant challenges to economic stability and growth. Proactive measures are essential to safeguard against the detrimental effects of inflation on livelihoods and business operations.
In Pakistan, inflation is typically measured through the Consumer Price Index. This index reflects changes in a basket of goods and services commonly consumed by the population. By tracking these changes, authorities can take timely corrective action.
Central banks and governments set inflation targets as a prudent economic measure to maintain price stability and foster economic growth. They ensure that actual price patterns align with the stipulated targets. Monitoring inflation through CPI helps legislators make informed decisions to mitigate its adverse effects on the economy. Adjusting policies in response to CPI fluctuations is the key for preserving purchasing power and sustaining economic stability.
Inflation stems from various drivers, each with distinct underlying causes. Factors, such as increased demand, reduced supply, geopolitical tensions and currency fluctuations can all contribute to inflationary pressures. A familiar challenge is the demand-pull inflation, where aggregate demand surpasses aggregate supply. This can occur due to heightened government expenditure or increased liquidity in the economy, leading to higher prices.
Consequently, those with limited income face difficulty affording goods and services at elevated price levels. Another relevant factor is the cost-push. Cost-push inflation is driven by rising production costs. This results in producers passing on incremental costs to consumers through price hikes.
Supply-chain disruptions, stemming from natural disasters, regulatory changes or technological advancements, can trigger cost-push inflation. These events disrupt the production process, leading to increased costs and subsequent price increases for consumers.
Policymakers must carefully monitor these drivers and adopt strategies to maintain price stability and promote sustainable economic growth. By effectively managing inflation, governments can help safeguard the purchasing power of consumers and ensure overall health of the economy.
In today’s global economy, inflation is influenced not only by domestic factors but also by international dynamics. Changes in one part of the world can directly affect inflation rates elsewhere. For instance, fluctuations in fuel and energy prices, essential inputs for all economies, can have far-reaching effects.
A decline in global oil prices due to reduced demand in a one economy can impact global prices. Similarly, exchange rates, reflecting a country’s external position, play an important role. A weak exchange rate exacerbates inflationary pressures, compounding the overall impact.
The interconnectedness of economies raises the importance of understanding global economic trends. Policymakers must consider international factors when formulating inflationary policies. Collaborative efforts between countries are essential for managing global inflation and promoting economic stability. Strengthening international cooperation and coordination can help mitigate the adverse effects of inflation on economies worldwide. Ultimately, a comprehensive approach is needed to address the global inflationary pressures.
Managing inflation effectively requires policymakers to implement coordinated measures across monetary, fiscal and supply-side domains to promote price stability and sustainable economic growth. Monetary policy tools, such as adjusting interest rates or conducting open market operations, are commonly employed by central banks to regulate inflation.
In times of high inflation, central banks may raise interest rates to curb excessive market liquidity, encouraging individuals to save rather than spend impulsively, thereby mitigating demand-driven inflationary pressures.
Fiscal measures, such as taxation adjustments and government spending reallocations, can also help alleviate inflationary pressures. For instance, higher taxes and reduced developmental expenditures can temper demand, curbing inflationary trends. Additionally, administrative actions aimed at curbing market manipulation, preventing hoarding and fostering competition and innovation play a critical role in enhancing output and reducing costs.
By implementing these comprehensive strategies, officials can effectively manage inflation and promote economic stability. Collaboration between governments, central banks and regulatory authorities is essential for implementing coordinated policies to address inflationary challenges. A holistic approach that integrates monetary, fiscal and administrative measures is necessary to achieve long-term price stability and sustainable economic growth.
An import-based economy, Pakistan faces severe inflationary pressures due to decades of economic mismanagement and fiscal imbalances. Since June 2022, the country has been struggling with hyperinflation, which reached 38 percent in May 2023. The average inflation rate has been a staggering 28 percent. This has exacerbated the overall economic difficulties, depleting reserves and savings of businesses as well as individuals. Managing necessities like food, health, and education has become increasingly challenging.
Rising energy prices have added to the chaos, consuming a significant portion of household income and leaving little to cover essential needs. The prolonged inflationary period has eroded the purchasing power and strained household budgets, leading to financial distress for many families. Businesses, too, are facing tough challenges, as rising costs reduce profitability and hinder investment and expansion efforts.
Addressing inflation requires comprehensive strategies that prioritise price stability and economic resilience. The government must implement measures to curb inflation while ensuring equitable access to essential goods and services for all citizens.
By taking decisive action and fostering cooperation, Pakistan can mitigate the adverse effects of inflation and pave the way for sustainable economic growth. As a monetary policy measure, the policy rate has stood at 22 percent since June 2023. Despite maintaining the rate in its recent Monetary Policy Committee meeting on April 29, the central bank has acknowledged a moderation in inflation, which declined to 20.7 percent in March, the lowest reported rate since June 2022. This downward trend reflects the impact of strict economic management strategies and the high base effect. However, the long-term effectiveness of these measures depends on the sustainability of this decline.
The MPC remains cautious about potential risks, including volatility in global oil prices and the resolution of circular debt in the energy sector, which could reignite inflationary pressures. Additionally, changes in tax rates may influence inflation dynamics in the future.
To overcome inflation, policymakers should focus on minimising policy rates, maintaining fiscal discipline and controlling government expenditures while boosting revenue generation through efficient and equitable tax policies. By adopting these measures, Pakistan can achieve price stability and foster sustainable economic growth and inclusive development in the long run.
Dr Ikramul Haq, an advocate of the Supreme Court and writer, is adjunct faculty at Lahore University of Management Sciences.
Abdul Rauf Shakoori is a corporate lawyer based in the USA.
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