Inflation’s complex process

Inflation is a complex process and it is difficult to find a single empirical model that fits the circumstances of each country. There is, however, little disagreement that in the long run inflation is a monetary phenomenon; high rates of price increase cannot be sustained for long periods without monetary nourishment

By Aftab Ahmad Khan

Inflation may be of two types; suppressed or open. It is open when prices rise without check. According to the noble laureate Prof Milton Friedman, open inflation refers to an “inflationary process in which prices are permitted to rise without being suppressed by government price controls and similar techniques.” Suppressed inflation refers to those conditions in which as a result of adopting the policies of price control and rationing on the part of the government, prices are prevented from rising. Suppressed inflation bursts on the removal of controls and rationing and develops into an open inflation with a vengeance. Wartime controls are an example of suppressed inflation; post-war inflations are examples of suppressed inflations developing into open inflations. The word suppression in the context of inflation implies: (a) the postponement of the present demand to some future date; and (b) the diversion of demand from one kind of goods to another, from those goods which are subject to price control to those goods whose prices are uncontrolled and whose supplies are not rationed.

Inflation is a complex process and it is difficult to find a single empirical model that fits the circumstances of all countries. There is, however, little disagreement that in the long run inflation is a monetary phenomenon; high rates of price increase cannot be sustained for long periods without monetary nourishment. Monetisation of fiscal deficits is frequently the major source of excessive monetary expansion in developing countries. Although a sustained rise in inflation is only possible if it is accommodated by monetary expansion; episodes of high inflation can be triggered by other developments as well. Large depreciations of the nominal exchange rate are widely regarded as a cause of inflation. There is indeed some evidence that episodes of high inflation in countries like Argentina and Brazil have been initiated by devaluations and thereafter sustained by an accommodating monetary policy. Another potential source of inflationary impulses is the supply shock that many have inflationary repercussions if financial policies are accommodating. For example, structural reforms in developing countries at the behest of International Monetary Fund (IMF) may create temporary inflationary pressures when prices are being de-controlled and subsidies cut. Wage and salary increases in excess of productivity gains and infrastructure bottlenecks (e.g. energy shortage and inadequacies of transport) can also exercise inflationary pressures. The non-monetary sources of inflation, however, cannot be perpetuated unless these are sustained by inappropriate monetary policies.

Many economists have frequently emphasised that inflation is more than an economic problem. This is because of their belief that money supply in a modern economy is a sociologically determined variable. Behind the excessive supply of money, lie complex socio-political forces struggling over the distribution of income and wealth. Various groups, strata and classes in contemporary economies are engaged in an organised struggle over the distribution of shares. This distributional struggle is not new but it has acquired certain new dimensions which compel the state to continuously increase the supply of money. In a situation of intensified struggle over distributive shares, governments are faced with a dilemma of either suppressing or mitigating the conflict which threatens the very foundations of market oriented economies.

Suppressing the distributional dissent requires curbs on trade union activity, imposing the of stringent discipline on workers by means of unemployment, curtailment of hard won political rights of the people and so on. Such a roll back of social progress or suppression of internationally recognised rights is to some extent possible under autocratic regimes. In a democratic setup it is not feasible. Hence the other alternative with the government is to expand money supply to meet the claims of every section and group in society. The resulting inflation thus becomes an effective short run softener of social conflict.

Persistent high inflation, as an aspect of development will never be condoned by anyone who has observed its consequences in a large number of countries across the globe. These include accentuation of inequalities in society, the disorganisation of public services, the misallocation of resources, the distortions of incentives, the flight of capital abroad and stagnation when stabilisation is ultimately attempted. By then habits of savings are greatly impaired and stabilisation eliminates the forced savings that result from credit expansion and deficit financing so that little internal savings remain.

“The most unrelieved victims are those who work for the state. Discrimination against the public services is an organic feature of endemic inflation. Public administration in Pakistan and a large number of other developing countries has consequently been deeply demoralised and eroded.

This is reflected in its inability to enforce laws including those that relate to taxation and other public revenues as well as in its failure to maintain and improve basic social services like education, health, transport, electricity, water and drainage. Over much of the world, there is also a rough and not accidental correlation between persistence of inflation and political insatiability.