Short Term vs. Long Term Remedies of Inflation

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Short Term Remedy vs. Long Term Solution
Term Paper

Prepared for:
Dr Mohammed Farashuddin
Visiting Professor
Macroeconomics (E202)

Prepared by:
Nafiz Alam Khan Bishal (ZR 47)
BBA 18th
Section A

21 May 2012
Institute of Business Administration
University of Dhaka

1. Introduction3
1.1. Variations of Inflation:3
1.2. Causes of Inflation4
2. Effects of Inflation4
2.1. Negative effects of unanticipated inflation:4
2.2. Positive effects of inflation:4
2.3. Overall effects of inflation:5
3. Remedies6
3.1. Short term remedy of inflation:6
3.1.1. Monetary Policy:6
3.1.2. Fiscal Policy:7
3.1.3. Export and Import:8
3.2. Long Term Solutions of Inflation:8
3.2.1. Cost of Production:9
3.2.2. Education and Training:9
3.2.3. Population Planning:9
3.2.4. Economic Planning:10
3.3. Analysis:10
3.4. Mistakes made by governments over the years:11
4. Conclusion12

1. Introduction

If we went back a year in time, we would still be able to purchase two candies in one taka. The same brand of candies is now sold at 1TK each. The increase in the price of this particular candy is affected by a number of economical factors. Maybe, the demand has grown faster than the supply for the candy or the cost of production has increased since last year. This growth of price is known as inflation. In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time (Blanchard, 2000). Consequently, inflation also reflects erosion in the purchasing power of money – a loss of real value in the internal medium of exchange and unit of account in the economy (Central Bank of Iceland).

1.1. Variations of Inflation:

* Deflation is a general decline in prices, often caused by a reduction in the supply of money or credit. This is the opposite of inflation. * Hyperinflation is unusually rapid inflation. In extreme cases, this can lead to the breakdown of a nation's monetary system. One of the most notable examples of hyperinflation occurred in Germany in 1923, when prices rose 2,500% in one month! If the inflation rate of an economy exceeds 50% per month, it is defined as hyperinflation (Mankiw, 2007). * Stagflation is the combination of high unemployment and economic stagnation with inflation. This happened in industrialized countries during the 1970s, when a bad economy was combined with OPEC raising oil prices.

1.2. Causes of Inflation

1. Demand pull inflation
2. Cost push inflation
The first theory suggests that the demand of a commodity has risen higher than its supply in the consumer market- a phenomenon which occurs quite often in growing economies. With the pull on demand, the prices increase. The latter theory argues a producer’s point of view. To keep up with the growing costs of production, the producers have to increase the selling price and maintain their profit margins. Thus, the prices go up causing inflation to take place.

2. Effects of Inflation

2.1. Negative effects of unanticipated inflation:
* Creditors lose and debtors gain if the lender does not anticipate inflation correctly. For those who borrow, this is similar to getting an interest-free loan. * Uncertainty about what will happen next makes corporations and consumers less likely to spend. This hurts economic output in the long run. * People living off a fixed-income, such as retirees, see a decline in their purchasing power and, consequently, their standard of living. * The entire economy must absorb re-pricing costs ("menu costs") as price lists, labels, menus and more have to be updated. * If the inflation rate is greater than that of other countries, domestic products become less competitive.

2.2. Positive effects of inflation:
* Nominal wages are slow to adjust downwards. This can lead to prolonged disequilibrium and high unemployment in...
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