International Research Journal of Finance and Economics ISSN 1450-2887 Issue 68 (2011) EuroJournals Publishing, Inc. 2011 http://www.eurojournals.com/finance.

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Impact of Inflation on Household Consumption -A Case of Pakistan

Muhammad Mazhar Manzoor Business Administration Department, FUUAST, Gulshan-e Iqbal, Karachi, Pakistan E-mail: mmazher@gmail.com Tel: +92-321-2342155 Asad Ali Siddiqui Lecturer, FUUAST, Islamabad, Pakistan E-mail: sidu4b@gmail.com Abdul Sattar Lecturer, Faculty of Management sciences, BIITEMS, Quetta, Pakistan E-mail: abdulsattarbaloch@gmail.com Muhammad Fahim Business Administration Department, FUUAST, Gulshan-e Iqbal, Karachi, Pakistan E-mail: faheemsiddiqui@yahoo.com Shagufta Rasheed Mezan Bank, Gulshan-e Iqbal, Karachi, Pakistan Abstract In this era of globalization, inflation crosses borders and affect to both developing and developed countries and now inflation is a major problem of todays world including Pakistan. It is generally felt that for several years, Pakistan has had double digit inflation. This study maps out the impact of inflation on consumption decisions of households. The hypothesis of the study is proposed as there is significance impact of inflation on household consumption and the ANOVA has been used to test the hypothesis. The findings prove that in Pakistan household consumption is subject to decrease with the increase in inflation. This study sets ground for further research regarding the impact factors and remedies for such problems.

Keywords: Inflation, Household Consumption

1. Introduction
In this era of globalization, inflation crosses borders and affect to both developing and developed countries and now inflation is a major problem todays world including Pakistan. The term Inflation means sustained increase in the general price level of Goods and services against a standard level of purchasing power of consumer, leading to fall in the currencys purchasing power. The flip-side of inflation is deflation. This occurs when average prices are falling, and can also result in various

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economic effects. For example, people will put off spending if they expect prices to fall. Sustained deflation can cause a rapid economic slow-down. The effects of Deflation are Company profits may fall, Private domestic capital investment may fall, Unemployment may increase and Real value of land to be repaid may rise, Central bankers believe that mild inflation, in the 3 to 4 percent is the most benign for a country economy. High inflation can cause adverse effect on the economy because every individual is affected in his life style, comforts, health etc. and uncertainty about future inflation may discourage investment and saving. When inflation happens consumer question is how their income hold up with changes in their expenses and producer think how to correlate the prices of their products with their cost. An increase in the general level of prices implies a decrease in the purchasing power of the currency. So the value of money decreases. That is, when the general level of prices rises, each monetary unit buys fewer goods and services and High inflation pushed more peoples into poverty. There are many factors that might directly or indirectly cause of inflation like Government budgetary structure, price of imported goods or price level in other trading countries government borrowing from central bank and private sectors, Trade deficit, exchange rate and home remittance etc. but the above mentioned three theories generally cover of all the issues. The purpose of this research is to determine the public attitude towards inflation and deflation that faced by Households. The objective of this study is to investigate the role of money supply, Fiscal deficit, Trade deficit, exchange rate, Oil and Wheat prices in overhead inflation using data of fiscal year FY Jun 2001 through FY Jun 2010 and due to inflation impact on consumption decisions of household.

2. Literature Review
The monetary growth, supply side and international factors are the key determinants of inflation in the country. Monetary authority in Pakistan responded to this increase in prices and there is an impact of monetary policy on inflation but with time lag. The causes of the consumer price inflation are too many, beginning with the basic food and non food items, international shocks, low productivity in the agricultural and industrial sectors and ill management on account of supply and storage of basic food items (Chahudary A. & Ahmed N., 1995). According to Asian Development Outlook (2005), Inflation in Pakistan is because of shortages of essential goods, higher housing rates, a steep rise in oil wheat and prices and strong demand pushed inflation. Food prices have increased sharply since mid-2007 and accelerated alarmingly in early 2008. Rice and wheat prices have spiked at levels not seen in over three decades. This threatens to exacerbate poverty in developing Asia by reducing the real incomes of the already poor, while pushing many others below the poverty line. The report proposes appropriate policy responses to the challenge of food price inflation in order to avoid the reversal of the gains in poverty reduction in the region. A similar analysis was made by William E. James, (2008), according to him several domestic and international factors have contributed to the extraordinary flow in the domestic price levels in Pakistan. The high price of food and energy in the international market can be primarily blamed on a confluence of factors that are not only structural and cyclical in nature but also involve demand and supply dynamics. While the wheat crises in 2005- 2006 and sugar crises in 20072008. Food inflation has emerged as a major source of concern for policy makers around the world including Pakistan because of shortage of wheat flour were compounded by steep hikes in prices of all major food items such as rice, pulses, edible oil, and spice. The current spike in food prices is attracting attention globally and alleviating the negative impacts at the household and national level. Poor households are particularly vulnerable to the higher costs of food and governments of low-income food importing countries face higher import bills and higher energy prices. However, there has been little attention thus far to the effects of higher food prices at the intra-household level, and specifically the impacts on children and child wellbeing. Rebecca H. et al, (2008) explored that households experienced high food prices as a shock. Most households have tried to cope with the high food prices by reducing non-food expenditures. Food price hike has severely battered their purchasing power. The poorest households now need to spend 70% or more of their income on food and their ability to meet

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most essential expenditures for health and education is severely compromised. In addition, the diminished purchasing power has severely impaired the capacity of the poor households to seek health care, and children education. Balbi L. et al, (2008) pointed that the food inflation index is currently over 12% and has shown no sign of coming down. The prices of essential food items like cereals, vegetables, pulses, meat, milk products are enormous as compared to the prices earlier in the year. While the pinch is felt by every household, the poorest sections are understandably the worst affected. According to SEWA Survey, (2008) Government budget deficit in the long run has a positive effect on prices in Iran. (Abbas A. and Sanhita A., 2009) Supply and demand factors could be responsible for this surge in inflation. Supply side shocks can cause large fluctuations in food and oil prices. The inflation in 2008-2009 is mainly powered by food items. This problem with food especially, Wheat is either being hoarded or smuggled to Afghanistan where the traders are getting a better return. Households with low levels of assets have been particularly adversely affected by the food price inflation. Lacking the financial resources to self-insure, and being referred to informal employment and volatile earnings because of low skills, the urban poor appear to be highly vulnerable to food price shocks and education appears to play a small role for the ability to cope with food price inflation. Alem Yonas and Sderbom Mns, (2010) explained that Planned increases in electricity and gas prices, international commodities price pressure influence people's expectations of future price level trends and impart to inflation. The likelihood of an uptick in inflation in the remaining months of FY10 thus seems quite conceivable.SBP expects the average CPI inflation for FY10 to remain between 11 and 12 percent. (Monetary Policy Statement January 2010)
Table 1:
Year

Consumer Price
Rank 90 123 143 186 168 162 204 210 Percent Change -25.64 % 65.52 % 89.58 % -13.19 % -3.80 % 167.11 % -30.05 % Date of Information 2002 est. 2003 est. FY03/04 est. 2005 est. 2006 est. 2007 est. 2008 est. 2009 est.

Inflation rate (consumer prices) 2003 3.90 % 2004 2.90 % 2005 4.80 % 2006 9.10 % 2007 7.90 % 2008 7.60 % 2009 20.30 % 2010 14.20 % Source: CIA World Fact book

The most serious costs of persistent inflation may be that it destroy our confidence that society can solve its problems and creates fear that our social contracts is falling apart.(Edward Foster , 1981) The loss of purchasing power, even if temporary, can have a severe impact on childrens schooling. Income matters for childrens school enrolment. In Burkinab`e, from 1994 to 1998 peoples experienced more than 30 percent decline in their income. This led to a substantial cut in their spending on education and a drop of more than ten percent in enrolment rates. This corresponds to more than 100,000 children which were not enrolled or were withdrawn from school during that period. In his work, G. Michael, (2001) identified that large family continuously decline in their consumption pattern due to exchange-rate-based inflation. Currency pegs, borrowing constraints and relative price of non tradable increase gradually for several years. The real exchange rate gradually appreciates must necessarily be accompanied by a continuous decline in consumption. According to Stefania A., (2007), the number of poor in Pakistan has risen from 60 to 77 million because of food inflation. Food inflation has pushed 17 million more Pakistanis in to poverty. Inflation increase the poverty in the country it decreases the purchasing power of consumer that increases the incident of poverty. Qayyum A., (2002) expounds the linkage between the excess money supply growth and inflation in Pakistan and to test the validity of the monetarist stance that inflation is a monetary phenomenon. The results from the correlation analysis indicate that there is a positive association between money growth and inflation.

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The money supply growth at first around affects real GDP growth and at the second around it affects inflation. The important findings from the analysis is that the excess money supply growth has been an important contributor to the rise in inflation in Pakistan during the supply period, thus supporting the monetarist proposition that inflation in Pakistan is a monetary phenomenon. This may be due to the loose monetary policy adopted by the state bank of Pakistan to show the high priority of the growth objective. The important policy implication is that inflation in Pakistan can be cured by a sufficiently tight monetary policy. The formulation of monetary policy must consider development in the real and financial sector and treat these sectors as constraints on the policy. Hasan A. M., (1995) pointed out that Pakistans negative trade balance is a constant problem since 50s and its causes lie not in international trade but in factors affecting international capital flows. The stage has come when the problem of a deficit coupled with high inflation and low economic growth is causing the balance of payments problems to be more serious. Friendly countries are reluctant and market borrowing does not seem likely because of Pakistans downgraded risk rating. Privatization of national assets on dismally low prices during the period of ongoing recession is poor choice and borrowing from the IMF has started showing stresses on the public. Factors affecting the trade deficit are largely of domestic origin and that can be fixed or alleviated by the tools of the national budget and trade policy both.

3. Methodology
This research analyzes the cause and effect relationship. The variables for this research are Household consumption products and services such as Food items, Education, Transportation, Entertainment, clothes, shoes and personal appearance, Medicare, fuel and lighting, use of public services, Household furniture, house rent and home appliance, and also include those variables that affect on household consumption behavior such as Indirect taxes, poverty level, variation in currency , Exchange rate, Budget deficit, money supply, political instability, trade deficit(Rising trade deficit can be a cause of expectation of high inflation in future). Inflation has positive association with indirect taxes, fiscal deficit, food prices, trade deficit (rising import prices) money growth (If government borrowing internally or externally will result in printing of more money and money supply increases faster then real output then inflation will occur), political instability, exchange rate (exchange rate fluctuation affect on general price level and cause inflation),rising oil and wheat prices are also positive relation with inflation. Methodology of the study comprises of sampling procedure, determination of sample size and the methods adopted to analyze the data collected from the sample respondents keeping in view the objectives of the study. The data used for this study comprise of both primary and secondary data. Primary data have been collected by circulation of a questionnaire while the secondary data were obtained from the published sources, the departments concerned and other relevant agencies which possessed statistical information, primary data were collected from the sample size from universe of this study. 3.1. Plan of work and Research Design This research is Qualitative and causal because determine the Household Demographics and due to inflation impact on consumption decision of household. The Questionnaire was distributed in House hold heads. The data were collected through multiple choice questions based on a Likert rating and a sample of 400 respondents was selected for study through cluster random sampling. 3.2. Hypothesis H0: There is no impact of inflation on household consumption H1: Inflation significantly reduces the household consumption

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4. Data Analysis and Discussion

Initially a sample of 400 respondents was selected but out of which 50 questionnaires were not received and 45 were incomplete, therefore the sample size was reduced to 305 respondents only. 4.1. Reliability Analysis The reliability of the scales is determined through Cronbachs Alpha and all the variables are found reliable. The Cronbachs Alpha of data is .818 which indicates strong reliability and validity. 4.2. Descriptive Analysis Following table summarizes the descriptive results of the study.
Table 2: Descriptive Analyses
Std. Deviation .55325 .50957 .62016 .47085 .46775 .49855 .44579 .44579 .42738 .43514 1.23630 .52426

N Decrease the daily consumption quantity of food Children Schooling Decrease the entertainment Increase use of Public Services Purchase from Utility Stores Utility store Support monthly budget Decrease the Buying frequency of personal appearance products Decrease the buying regularity of home appliances Turned from expensive to inexpensive goods Consumption to saving Government supportive programs Benefits receive from government support programs Valid N (listwise) 305 305 305 305 305 305 305 305 305 305 305 305 305

Minimum 2.00 2.00 3.00 3.00 4.00 4.00 4.00 4.00 4.00 4.00 1.00 2.00

Maximum 5.00 5.00 5.00 5.00 5.00 5.00 5.00 5.00 5.00 5.00 5.00 5.00

Mean 4.0984 4.1410 4.0164 4.2033 4.3213 4.4525 4.2721 4.2721 4.2393 4.2525 2.1049 4.0689

Variance .306 .260 .385 .222 .219 .249 .199 .199 .183 .189 1.528 .275

Each factor is measured on a five point rating scale, where 1 indicates the lowest level of intensity and 5 indicates the highest level of intensity. Table-1 shows the average level of intensity of each subscale along with their standard deviation. On the basis of variance determine the impact of inflation on consumption decisions. Like Due to inflation household decrease the consumption quantity of food (mean 4.09), affect on children schooling (mean 4.14), Decrease entertainment services (mean 4.01), Frequently use public services (mean 4.20), prefer to purchase from utility stores(mean 4.32), Utility stores support monthly budget (mean 4.45), Decrease the Buying frequency of personal appearance products (mean 4.27), Decrease the buying regularity of home appliances (mean 4.27), Turned from expensive to inexpensive goods (mean 4.23), Benefits receive from government support programs (mean 4.06) 4.3. Hypothesis Test Analysis of variance is used to test the hypothesis. This technique is an extension of the two-sample t test. Here testing the hypothesis of both questionnaires. Analysis of variance is applied on subscales to check whether all subscales have the same impact of inflation on consumption or not.

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Table 3: Test of Homogeneity of Variance
Levene Statistic 30.801 df1 2 df2 302 Sig. .000

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Household Response

The above table provides the degree of freedom and the significance level, df1 is one less than the number of samples (3-1=2) and df2 is the difference between the total sample size and the number of samples (305-3=302). The results show the variances of the groups are significantly different.
Table 4: Anova
Sig. P value .000

Household Response

Between Groups Within Groups Total

Sum of Squares 43.898 49.151 93.049

df 2 302 304

Mean Square 21.949 .163

F 134.861

The above results show that F is 134.861 this rejects the null hypothesis and thus alternative hypothesis is accepted, there is a significant impact of inflation on household consumption.

5. Conclusion
Inflation is a burning issue in Pakistan; it is generally felt that for several years, Pakistan has had double digit inflation. It is one of the microcosmical variables; whish has negative impact on economic activity. The CPI is used to calculate inflation in Pakistan. Inflation decreases the value of money, which ultimately effect on investment. Inflation adversely affects the overall growth, the financial sector development and the vulnerable poor segment of the population, Inflation decreases the real income and also induces uncertainty. For analyzing data use ANOVA and descriptive analysis and also find mean plot for testing hypothesis to determine the impacts of household demographics on their consumption behavior The main finding indicates that more than half of the surveyed households experienced high prices as a shock. The poorest households now need to spend more of their income on food and their ability to meet most essential expenditures for health and education is severely compromised. It negatively affects household access to health, education and other social services. Most of the surveyed households more frequently use public services (transportation, healthcare etc) during inflation that put extra burden on it. Thus the statistics have shown that there is a significant impact of inflation on household consumption.

References
[1] [2] [3] [4] [5] [6] Chahudary A. M. & Ahmed N. (1995),Money supply Deficit &inflation in Pakistan, Pakistan Development Review,vol-34(4), pp-945-956 Asian Development Outlook 2009 William E. James, (2008), Food Prices and Inflation in Developing Asia: Is Poverty Reduction Coming to an End?, Asian Development Bank Rebecca H. et al, (2008), Understanding the impact of Food Prices on Children, Children in Focus Plan UK Balbi L. and et al, (2008), High Food Prices in Pakistan Impact Assessment and the Way, The UN inter agency assessment mission FAO/UNDP/UNESCO/ UNICEF /WFP/WHO SEWA Survey (2009), Impact of price rise on poor Households

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International Research Journal of Finance and Economics - Issue 68 (2011) Abbas A. and Sanhita A., (2009), The impact of the budget deficit on inflation in the Islamic Republic of Iran Alem Yonas and Sderbom Mns, (2010), Household-Level Consumption in Urban Ethiopia: The Impact of Food Price Inflation and Idiosyncratic Shocks, Monetary Policy statement of State Bank in Pakistan (1990-2009), Publication of State Bank. Foster Edward (1981),Who losses from Inflation, Annuals of the American academy of political and social sciences, sage publications, vol. 456, pp 32-45 G. Michael, (2001), Food Price Inflation and Childrens Schooling, German Institute for Economic Research Stefania A., (2007), Inflation and inequality, Journal of Monetary Economics, vol-54,pp1088-1114 Qayyum A., (2006), Money, Inflation, and Growth in Pakistan, Pakistan institute of Development economics, vol-45(2), pp-203-212 Hasan A.M., (1995), What explain the current high rate of inflation in Pakistan, The Pakistan Development Review, vol-34 (4), pp 927-943 Hasan A.M., (1995), What explain the current high rate of inflation in Pakistan, The Pakistan Development Review, vol-34 (4), pp 927-943.