Inflation & Money Supply

Topics: Inflation, Monetary policy, Money supply Pages: 12 (3376 words) Published: November 16, 2012
Inflation & Money Supply

Econ 302
Fall Semester

Salman Sharoon John

Department Of Economics
(A Chartered University)

Acknowledgements: I would like to thank Mr. Zahid Iqbal, Luqman Saeed & Keizer Xavier for the help and all the time needed in knowing and studying the variables and helping in this research paper. Introduction:

Inflation is a burning issue in Pakistan. Pakistan has double digit inflation. The factor determine the inflation, first of all money supply are the major determinant of the inflation. In case of Pakistan concluded that in the long run excess money supply is the main factor responsible for inflation. The data given below is from year (1998-2008). Data shows that how much percentage change was change every year. Controlling inflation is a high priority for policy-makers. But the instability of the economy it is not possible to control inflation. Every year the percentage of inflation will increase, some other determinants are discussed. Inflation is also determines on imports, so government increase the taxes on imports, if the imports will reduce and the exports will increase the rate of inflation must be decreased. The background disinflation policy in many countries is framed with the objective of constraining monetary growth to be in line with the expansion in nominal income. Hence, an increasing number of countries have granted their central banks autonomy in the hope that it will insulate them from having to accommodate imprudent fiscal policies. Money demand should depend on expectations about future inflation; a purely monetary effort at reducing inflation may not be successful. Theoretically, once account is taken of forward-looking expectations, multiple equilibrium paths for inflation can coexist. Under such circumstances, money supply alone may not be sufficient to pin down the time path of inflation. Against this background, attention has increasingly been given to the role of fiscal policy in determining inflation. In seminal paper by Sargent and Wallace (1981) is that the effectiveness of monetary policy in controlling inflation depends critically on its coordination with fiscal policy. In their model, tighter monetary policy could lead to higher inflation under certain circumstances, even when the traditional relation between money and the price level holds. The rationale is that, with the demand for government bonds given and in the absence of changes in future fiscal policy, a part of government obligations has to be covered by seignorage at some point in the future. A similar line of reasoning lies behind the fiscal theory of the price level (FTPL). Apart from seignorage financing, traditional analysis of the fiscal impact on inflation focus mostly on Keynesian aggregate demand considerations, public wage spillovers to private sector wages, and taxes affecting marginal costs and private consumption Literature Review

Pakistan is facing a major downfall in the economy, the deficits and a high rate of inflation. Inflation in Pakistan has been gone to double digit that is a major problem[1]. Fiscal deficit was around 7.4 percent of the GDP during the period of 1970-80, and 7.6 percent during the 1980. The major problems that have been placed are double digit inflation that increased the poverty[2]. On the other hand the current account balance is disturbed. The major reasons for that were excess government spending and a major trade imbalance, in which the imports were greater than the exports. The country's huge budget deficit as well as high rates of growth of money did have a significant impact on the inflation rate. The article says that due to domestic borrowing to overcome the deficits increase inflation in the long run. There is a positive relation between the deficit and inflation, because due to borrowing from the foreign bank. To overcome the deficit the debt has to be paid in...
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