ARTICLE (March 04 2010): Originally, "inflation" was used to refer simply to monetary inflation, whereas in present usage, it often refers to price inflation. Members of the Austrian School of Economics, also dominating Pakistani economists, make no such distinction, maintaining that monetary inflation is inflation.
Consequently, the earlier governments of Pakistan, including the present one, have always tried to deal the issue of inflation through interest and exchange rate adjustments apart from money supply and maintenance of financial discipline in borrowings that is, from monetary policy perspective.
This attitude has turned blind eyes towards the fiscal policies responsibility, corruption and parallel economy that led our policies to limit the inflation in astray. The ministry of finance never tried to align the fiscal and monetary policies even during the current recessionary period in line with history. Further, they never tried to use fiscal policies for combating recession except for adjustment of tax rates, curtailing exemptions and government spending that also remained unaligned with the monetary policy.
The idea of using fiscal policy to combat recessions was introduced by John Maynard Keynes in the 1930s, partly as a response to the Great Depression. Many nations of the world have enacted fiscal stimulus plans in response to the global recession during 2000s. These nations have used different combinations of government spending and tax cuts to boost their sagging economies.
Most of these plans are on the Keynesian theory that deficit spending by governments can replace of the demand lost during a recession and prevent the waste of economic resources idled by a lack of demand. Even the International Monetary Fund has recommended implementation of fiscal stimulus measures equal to 2% of their GDP to help offset the global contraction.
Without understanding the ground realities of inflation, our economists would tinker at the edges of problem instead of resolving the same. This article is meant for back to basics to unfold the terms price and monetary inflation in recessionary period, including the concept of business cycle, gross domestic product and capacity utilisation apart from concluding about the optimal solution from Islamic economics, which is followed globally in the name of fiscal stimulus plan.
INFLATION This refers to general level of prices of goods and services in an economy over a period of time. People generally understand that during the period of rise in price level each unit of currency buys fewer goods and services, that is, erosion in the purchasing power of money.
In other words, this erosion is a loss of real value in the internal medium of exchange and unit of account in the economy. The chief measure of price inflation in Pakistan is the inflation rate, an annualised percentage change in a general price index (commonly known as Consumer Price Index) over time.
Inflation is uncomfortably high in almost every corner of the world, creating serious difficulties for policymakers. Everywhere, the root-cause is raising food and fuel prices underpinned by surging demand from fast growing developing economies like China.
The longer food and energy prices keep pushing up overall inflation, the greater the chance that expectations of higher inflation would lead to bigger pay demands, thereby triggering a wage-price spiral, as witnessed in the 1970s.
In Pakistan, signs of consumers' angst about the inflation outlook are emerging as prices of oil, food and other commodities are rising. Inflationary pressure is not likely to ease owing to continuing increase in global food and fuel prices apart from monetary overhang from the unprecedented government borrowing from the SBP for budgetary financing.
POSITIVE AND NEGATIVE INFLATION Inflation was always been portrayed as a monster before the citizens of Pakistan, although it can have positive effect on an economy apart from its negativities.
Negative effects of inflation include a decrease in the real value of money and other monetary items over time as uncertainty about future inflation may discourage investment and saving, while high inflation may lead to shortages of goods, if consumers begin hoarding out of concern that prices will increase in the future.
Positive effects of inflation include a mitigation of economic recessions, and debt relief by reducing the real level of debt. Today, most mainstream economists around the globe favour a low steady rate of inflation. Low (as opposed to zero or negative) inflation may reduce the severity of economic recessions by enabling the labour market to adjust more quickly in a downturn, and reduce the risk that a liquidity trap preventing monetary policy from stabilising the economy.
Before we move on to the details of food and monetary inflation along with fiscal and monetary policies let's take a brief overview of some basic terminologies like recession, business cycle, gross domestic products and capacity utilisation.
RECESSION A recession is a business cycle contraction, a general slowdown in economic activity over a period of time. During recessions, many macroeconomic indicators vary in a similar way. Production as measured by gross domestic product, employment, investment spending, capacity utilisation, household incomes, business profits and inflation all fall during recessions; while bankruptcies and the unemployment rate rise.
Recessions are generally believed to be caused by a widespread drop spending. Governments usually respond to recessions by adopting expansionary macroeconomic policies, such as increasing money supply, increasing government spending and decreasing taxation. Surprisingly, we are working on the other way round that is working on contractionary macroeconomic policies.
BUSINESS CYCLE Business cycle (or economic cycle) refers to economy-wide fluctuations in production or economic activity over several months or years. These fluctuations occur around a long-term growth trend, and typically involve shifts over time between periods of relatively rapid economic growth (expansion or boom), and periods of relative stagnation or decline (contraction or recession) and that's what happened globally with no exception to Pakistan.
These fluctuations are often measured by using the growth rate of real GDP. Despite being termed cycles, most of these fluctuations in economic activity do not follow a mechanical or predictable periodic pattern.
GROSS DOMESTIC PRODUCT The gross domestic product (GDP) or gross domestic income (CDI) is a basic measure of a country's overall economic output and represents the market value of all final goods and services made within the borders of a country in a year. The GDP can be determined in three ways - product (or output) approach, the income approach, and the expenditure approach and all give same result in principle.
The most direct of the three is the product approach, which sums the outputs of every class of enterprise to arrive at the total. The expenditure approach works on the principle that all of the product must be bought by somebody, therefore, the value of the total product must be equal to people's total expenditures in buying things.
The income approach works on the principle that the incomes of the productive factors ("producers," colloquially) must be equal to the value of their product, and determines GDP by finding the sum of all producers' incomes.
In the name "gross domestic product," "Gross" means that GDP measures production regardless of the various uses to which that production can be put. However, production can be used for immediate consumption, for investment in new fixed assets or inventories, or for replacing depreciated fixed assets. If depreciation of fixed assets is subtracted from the GDP, the result is called the net domestic product; it is a measure of how much product is available for consumption or adding to the nation's wealth. In the above formula for the GDP by the expenditure method, if net investment (which is gross investment minus depreciation) is substituted for gross investment, then net domestic product is obtained.
"Domestic" means that the GDP measures production that takes place within the country's borders, in the expenditure-method equation given above, the exports-minus-imports term is necessary in order to null out expenditures on things not produced in the country (imports) and add in things produced but not sold in the country (exports).
Economists have preferred to split the general consumption term into two parts; private consumption, and public sector (or government) spending. Two advantages of dividing total consumption this way in macroeconomics are:
-- Private consumption is a central concern of welfare economics. The private investment and trade portions of the economy are ultimately directed (in mainstream economic models) to increases in long-term private consumption.
-- If separated from endogenous private consumption, government consumption can be treated as exogenous, so that different government spending levels can be considered within a meaningful macroeconomic framework.
The GDP is often positively correlated with the standard of living, though its use as a stand-in for measuring the standard of living has come under increasing criticism and many countries are actively exploring alternative measures to the GDP for that purpose. On the contrary, we are still stuck-up with the fashionable berths like tax-to-GDP ratio, which represents the market value of all final goods and services made within the borders of a country in a year just to see how much tax was contributed by the society out of its production not profit. Probably the government is well aware of its taxation policies like minimum tax and indirect taxes etc.
CAPACITY UTILIZATION This refers to the extent to which an enterprise or a nation actually uses its installed productive capacity. Thus, it refers to the relationship between actual output that 'is' produced with the installed equipment and the potential output, which 'could' be produced with it, if capacity was fully used the other day. Excess capacity means that insufficient demand exists to warrant expansion of output.
If market demand grows, capacity utilisation will rise. If demand weakens, capacity utilisation will slacken. Monetary economists and bankers often watch capacity utilisation indicators for signs of inflation pressures. They presumably believed when utilisation rises above somewhere between 82% and 85%, price inflation will increase. Excess capacity means that insufficient demand exists to warrant expansion of output.
All else constant, the lower capacity utilisation falls (relative to the trend capacity utilisation rate), the better the bond market likes it. Bondholders view strong capacity utilisation (above the trend rate) as a leading indicator of higher inflation. Higher inflation (or the expectation of higher inflation) decreases bond prices (producing a higher yield to compensate for the higher expected rate of inflation). This is against the very principles of Islamic economics by looking at the concept of Zakat, Sadqa and Islamic financial instruments.
Implicitly, the capacity utilisation rate is also an indicator of how efficiently the factors of production are being used. Much statistical and anecdotal evidence shows many industries in the developed capitalist economies suffer from chronic excess capacity. Critics of market capitalism, therefore, argue the system is not as efficient as it may seem, since at least 1/5 more output could be produced and sold, if buying power was better distributed in line with Islamic economics principles. It is pertinent to that level of utilisation somewhat below the maximum nevertheless prevails regardless of economic conditions.
Source: http://www.brecorder.com/index.php?id=1026816&currPageNo=1&query=&search=&term=&supDate=
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