Impact of Economic Growth and Employment Rate on Inflation

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ABSTRACT

This research paper presents empirically analysis of the impact of GDP growth rate and employment rate on inflation. For this purpose data from 1995 to 2008 has been collected and analyzed through OLS technique. The result of the model shows that GDP growth rate and employment rate adequately affect inflation. With the increase in GDP and employment, inflation decreases.

INTRODUCTION

Inflation is a burning issue in Pakistan. It is generally felt that for several years Pakistan has had a double-digit inflation. The public sector has used a mix of policies to control inflation, and it is also held responsible for its creation. The consumer price index (CPI) increased over 11 percent in 1981-82, and over 12 percent in 1990-91.

Similarly, sensitive price index (SPI) increased over 15 percent in 1981-82, and over 12 percent in 1990-91. The GDP deflator was also double-digit for several years. Inflation not only affects sectoral allocation and distribution of income but also generates poverty.

Several supply side and demand side factors could be responsible for this surge in inflation. Inflation can be a result of shocks to the supply of certain food items and to world oil markets. Rising oil prices can pose risk of increase in prices of almost all other commodities of the consumer basket. Such supply-side shocks are very volatile and can cause large fluctuations in food and oil prices. The effects of this on overall inflation at times can be so excessive that these cannot be countered through demand management, including monetary policy. However, greater emphasis in the recent debate on inflation remained on the demand side factors.

The demand side pressures were often considered as an outcome of the September 11, 2001 incident in the United States of America (USA) and a combination of expansionary monetary and fiscal policies. First, increased domestic demand due to remittances from abroad and liberal demand-management policies outpaced the domestic production, creating a positive output gap, which in turn put upward pressure on prices.

A recently conducted survey by the PIDE on inflation expectations reveals that people are expecting high inflation together with high unemployment, a decline in growth rate and decreasing currency value. The survey also shows that both demand pull and cost push factors are responsible for current inflation in Pakistan, the most prominent being global economic conditions and high food and fuel prices. High cost of living induced by inflation is now the most important problem in Pakistan. The most hurt are the lower income segments of the society followed by the middle income group.

In year (2007-08) government’s fiscal target for inflation was 6.5 per cent. While according to government figures, the CPI based inflation stood at 11.11 per cent during July’07 to April’08. In fact, fiscal sector indicators also moved in the same direction during the sub-periods mentioned earlier.

Inflation is one of the most researched topics in economics because it has serious implications for growth and income distribution. Inflation normally depends on many factors but in this paper its importance with respect to two factors are discussed, GDP and unemployment.

LITERATURE REVIEW

THEORETICAL BACKGROUND

Over time in Pakistan the growth in GDP has caused inflation, and inflation begets hyperinflation. Once this process is in place, it can quickly become a self-reinforcing feedback loop. This is because in a country where inflation is increasing, people will spend more money because they know that it will be less valuable in the future. This causes further increases in GDP in the short term, bringing about further price increases. Also, the effects of inflation are not linear; 10% inflation is much more than twice as harmful as 5% inflation.

In the case of Pakistan, annual inflation was above 11 percent in 11 of the past 32 years. Not surprisingly, average real per...
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