DETERMINANTS OF INFLATION IN PAKISTAN

Navila Iram
MSC Economics, University of Sargodha
Mandi Bhauddin
Introduction
The effects of inflation on economy may take the forms of redistribution of income. It hurts
savers as price rises and real value or purchasing power of savings low deteriorates. Savings
accounts, increase polices, annuities and other fixed value paper assets meet decline in real value
during inflation unanticipated inflation benefits debitors at the expense of creditors. Inflation can
have series of adverse consequences for the economy (Khan and Gills, 2010).
Inflation low the purchasing power of the people and hence, leads to a contraction in economy
growth. It leads to increase in macroeconomic instability. Inflation is the reason to create poverty
in the country. The increase in overall prices hurts the poor more. Inflation can damage a
country's competitiveness by leading to an appreciation of the local currency and a consequent
overvalued exchange rate, which have negative effect exports.

In case of Pakistan the (mid-1970s) was the most inflationary time, with inflation rates over
going more than 15% annually. The oil price reached 20%by the middle of the decade. Compare
to the historical level of single digits, the inflation of the (1990s) created a serious disturbance.
In the era of (2001-2008) the inflation has shown a mixed trend. During (2001-04) inflation
remained low but CPI shot up in (2004-05) and it reached to 9.3%.It dropped to 8% in (2005-06)
it again short up in (2006-08) and reached to its historical high level.

Inflation means a rising trend in the general price level of a country. Inflation is sustained
increase in the price level at least consecutive 3 years ( Gills et al,1996).Inflation is an important
issue for a country. One of the important challenges for the government to stabilize price and
control it with in the limit of the people. Moreover, inflation disturb price level, discourages,
investment and is a Hazard to economic planning. Maintaining inflation rates within reasonable
targets continues to be one of the principal goals of the ongoing economic reforms. The
government through the monetary authorities has instituted tight monetary and fisical polices
which often target the demand causes of inflation. On the other hand there are real factors to such
as force production which also influences inflation. (Hussain and Islam 1985)

Inflation rate as measured by consumer price index CPI represent the trend of price of good and
services in the economy survey of Pakistan. If a loan is a major part of production sector, an
increase in interest rate would increase the cost of borrowing and enhance inflation. Similarly,
some scholars accused that indirect tax are the major causes of inflation. The wheat support price
WSP identifies as an Pakistan by(Khan and Qasim, 1996) and( Hassan et al, 1995).
Now the question is that How to determine the most significant explanatory factor for current
inflation in Pakistan. This paper shows the analysis of the dependent and explanatory variables.
It proceeds with a review of literature.
Literature view
IS the inflation bad for economy?
A considerable rate, about 3 to 6% for Pakistan (Khan and Hussain, 2005) is often evaluated to
have good effects on the economy. Nonetheless negative effects come out worth of money comes
down. Saving and investment are discouraged. As inflation reduces the real rate of return on
financial assets so the savings are discouraged. This again leads to lower economic growth as a
result of lower investments.
Hence, it becomes more important for policy maker to identify the real causes of inflation and
design strategies accordingly. To identify the causes, as a first step it necessary to develop the
theories of inflation and then see what recent literature leads us to:
Different schools of thought have presented their theories which discuss the causes of inflation.
Keynesian era where inflation was to be caused by either an increase in aggregate demand or a
decrease in aggregate supply. Fisical policy was supposed an important tool in controlling
inflation in the Keynesian point view.
During the 1950 s the issue of falling money wages led the Keynesian economists to investigate
new explanation. One investigation by A.W Phillips curve. This model was further modified by
(Lipsy, 1960).
Recent economic literature on inflation provides model that incorporate both demand and supply
side factor along with policy variables and adaptive expectations. The literature identifies the
following as main determinants of inflation: monetary shocks, inflation expectations, the price of
imports, exogenous supply and fiscal policy shocks. (Q. M. Ahmed, et al)

Nguyen et al (2012) employees a plain inflation macroeconomic model to empirically examine

the CPI inflation determinants. Employing time series evaluation methods; the discover that the
supply of money, rice prices as well as oil prices are the significant determinant of CPI inflation.

Econometric Methodology, Its justification and Model:

Engel Granger (Engle and Granger 1987)

OLS
Johanser C0-integration

The above mention techniques are applied to assess long run association among the selected
variables.
Whereas Engel Grangers is used for bivariate model and OLS is used when the selected variables
at level became stationary. This model is neither bivariate nor the stationary variables at level
therefor. It is useful to find the long run relationship by applying the johansen co-integration
techniques among the variables which are the CPI, ER, GB, RGNP, IT, GMS, IPI, and WSP.
Nonetheless ECM is used to check short run association among the variables.
ADF (Unit root Test) testing regression equation as follows:n

Y
1= B1+ B2 + SYt-1 + ai i1

t-1 + Et

Yt

Represents time series data

Represents first difference operator

Represents linear Trend

Represents constant

Represents Error term

The null hypothesis of unit root is B=0

Results and Discussion: When we go through econometrics analysis.
Conclusion:Will be provided on the basis of results and discussion.
References:Khan, M (2005), Inflation and growth in MCD countries Mimeo, International monetary fund.
Khan, M.S and Schimmelpfennig, A. (2006). Inflation in Pakistan, Money or wheat. Lipsey, R. (1960),
the relationship between Unemployment and the rate of change money wage rates in the United
Kingdom.

Nguyen, H.M, Cavoli T, & Wilson, J.K (2012).

Hassan MA, Khan AH, Pasha HA, Rasheed MA 1995.
What explains the current high rate of inflation in Pakistan. Khan A, Qasim M 1996 Inflation in Pakistan
revisited.