ASSIGNMENT

On Macroeconomics and Policy

Course code: MBA-026

Topic: Recent Inflation in our Economy and its Causes &

suitable Suggestions to solve this.

Prepared forSeikh Ruksana Burhan Lecturer, Dept. of Business Administration

Metropolitan University, Sylhet.

Prepared ByMir Md.Ahsan Huda ID: 112126035 MBA- 23rd batch Dept. of Business Administration

Metropolitan University, Sylhet.

Date of submission: 30-03-2012

Acknowledgment
I am deeply indebted to my internal guide Seikh Ruksana Burhan, Lecturer of Business Administration Metropolitan University, for her stimulating inspiration, attitude guidance, sagacious advices, & whole-hearted supervisions to me during the practical orientation period. Her suggestions and guidances has made the assignment a good one.

Mir Md.Ahsan Huda

ID: 112126035 MBA- 23rd batch Dept. of Business Administration

Metropolitan University, Sylhet

CONTENTS
#Page no.

IntroductionInflationEffects of InflationCauses behind InflationThe Key FindingsNeeded StepsConclusionBibliography-

03 03 04 04 07 08 08 09

Too much money in circulation causes the money to lose value-this is the true meaning of inflation. The popular opinion about the costs of inflation is that inflation makes everyone worse off by reducing the purchasing power of incomes, eroding living standards and adding, in many ways, to lifes uncertainties. In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time. INFLATION The word inflation is derived from Inflate which means to rise artificially. Generally inflation is a phenomenon whereby general price level rise persistently. Inflation is a situation whereby excess demand for goods in which too much money chasing few goods, Inflation has been gradually building up for many years. It is not restricted to few countries it is world wide problem. Creeping inflation is the term used to describe a rise in price level at a rate of 2 to 3 percent per annum. This type of inflation does not do very serious harm and it may, in fact, stimulate investment. Moderate inflation describes a rise of 4 to 5 percent per annum and this rate is high enough to have undesirable effects. Rapid inflation that is, a rise of 6 percent or over is positively harmful and has undesirable effects on incomes, imports and over all economic sector.

EFFECTS OF INFLATION General Effect An increase in the general level of prices implies a decrease in the purchasing power of the currency. That is, when the general level of prices rises, each monetary unit buys fewer goods and services. Increases in the price level (inflation) erode the real value of money (the functional currency) and other items with an underlying monetary nature (e.g. loans and bonds). For example if one takes a loan where the stated interest rate is 6% and the inflation rate is at 3%, the real interest rate that one are paying for the loan is 3%. It would also hold true that if one had a loan at a fixed interest rate of 6% and the inflation rate jumped to 20% one would have a real interest rate of -14%. Negative Effect High or unpredictable inflation rates are regarded as harmful to an overall economy. They add inefficiencies in the market, and make it difficult for companies to budget or plan long-term. Inflation can act as a drag on productivity as companies are forced to shift resources away from products and services in order to focus on profit and losses from currency inflation. Uncertainty about the future purchasing power of money discourages investment and saving and inflation can impose hidden tax increases. In case of international trade, Higher inflation in one economy than another will cause the first economy's exports to become more expensive and affect the balance of trade Positive Effect Positive effects include ensuring central banks can adjust nominal interest rates (intended to mitigate recessions), and encouraging investment in nonmonetary capital projects. It puts impact on Labor-market adjustments, Room to maneuver, Mundell-Tobin effect, Instability with Deflation etc. CAUSES BEHIND INFLATION In developing countries, in contrast, inflation is not a purely monetary phenomenon, but is often linked with fiscal imbalances and deficiencies in sound internal economic policies. Beside, factors typically related to fiscal imbalances such as higher money growth and exchange rate depreciation arising from a balance of payments crisis dominate the inflation process in developing countries. There were different schools of thought as to the causes of inflation. Most can be divided into two broad areas: 1. Quality theories of inflation

6
2. Quantity theories of inflation. The quality theory of inflation rests on the expectation of a seller accepting currency to be able to exchange that currency at a later time for goods that are desirable as a buyer. The quantity theory of inflation rests on the quantity equation of money that relates the money supply, its velocity, and the nominal value of exchanges. Adam Smith and David Hume proposed a quantity theory of inflation for money, and a quality theory of inflation for production. After analyzing two theories of causes we have got here some physical cause to face which cover both theories depending on a number of factors. These are given belowExcess of Money Inflation can happen when governments print an excess of money to deal with a crisis. As a result, prices end up rising at an extremely high speed to keep up with the currency surplus. This is called the demand-pull, in which prices are forced upwards because of a high demand. Effect of Unemployment It is one of the major problems in Bangladesh. The percentage of the work force that is unemployed at any given date is known as unemployment rate. In another word, An economic condition marked by the fact that individuals actively seeking jobs remain unemployed is known as unemployment. According to International Labor Organization (ILO), Unemployment occurs when people are without jobs and they have actively looked for work within the past four weeks. It is believed that unemployment is a serious social evil & the high rate of unemployment indicates unhealthy situation of an economy. If the full level of employment can be used then it is possible for a country to enrich itself. Each and every country in this world is trying to reduce the rate of unemployment for their betterment. Rise in Production Cost In Bangladesh the Rise in production cost another common cause of inflation is a rise in production costs, which leads to an increase in the price of the final product. For example, if raw materials increase in price, this leads to the cost of production increasing, which in turn leads to the company increasing prices to maintain steady profits? Rising labor costs can also lead to inflation. As workers demand wage increases, companies usually chose to pass on those costs to their customers.

7
International lending & national debt Inflation International lending & national debt Inflation can also be caused by international lending and national debts. As nations borrow money, they have to deal with interests, which in the end cause prices to rise as a way of keeping up with their debts. A deep drop of the exchange rate can also result in inflation, as governments will have to deal with differences in the import/export level. Federal Taxes Put on Consumer Products Inflation can be caused by federal taxes put on consumer products such as cigarettes or fuel. As the taxes rise, suppliers often pass on the burden to the consumer; the catch, however, is that once prices have increased, they rarely go back, even if the taxes are later reduced. War Wars are often cause for inflation, as governments must both recoup the money spent and repay the funds borrowed from the central bank. War often affects everything from international trading to labor costs to product demand, so in the end it always produces a rise in prices. Limitations of Economic System The quarterly data on budget deficit and government expenditures are not available, which hinders the analysis on the supply side determinants of inflation. The wage rate is not considered here because of the developing country nature, Labor is assumed to be abundant.

THE KEY FINDINGS Inflation in Bangladesh can be explained by money supply growth as money supply has statistically significant power of forecasting the movement in CPI. It might be channeled through either the effects of money supply on GDP or the effects of money supply on exchange rates. The deposit rate of interest is a relatively weak determinant of fluctuations in inflation in Bangladesh, whereas deposit rate of interest is a moderately strong determinant of nominal exchange rate, but only in the short run. Money supply is a moderate determinant of fluctuation in real output, at the same time; money supply is a moderately strong determinant of fluctuation in nominal exchange rate in Bangladesh during the period of FY90-FY10. In the fiscal year 2009, global oil price has shifted upward dramatically so fast. So that, the price of fuel & power has driven very sharp impact on our economy by increasing the price of Industrial product and reduces the output of industry. Though our government has taken needed initiatives to minimize the inflation rate but they have failed up to the expectation. In the fiscal year 2010, global food price has shifted upward dramatically so fast. That is why the price of food has driven very sharp impact on our economy. Though the inflation has decreased to a reasonable rate (5.4 percent), the price of food is beyond to the normal people. Because of the insufficiency of credit to productive sectors it is unable to invest money in productive sectors whereas the money are using in less productive sectors which causes a high rate of inflation.

NEEDED STEPS
The results have important policy implications for both domestic policy makers and the development partners.

Our first and foremost concern is to keep the inflation rate under 7 percent cause with this inflation rate growth is positive. Our government should take initiative to reduce deterioration of budgetary balance because budget deficit is the major obstacle to growth trend. Our government should take steps to increase foreign exchange reserve which will add a lot to growth. Taking into consideration that the inflation rate is not indexed in the wages and salaries, inflation will lead to a decrease in the purchasing power and an increase in the cost of living. Given that the country frequently has to balance the credit requirements by the private and public sector against both inflationary and balance of payments pressures, it is not always possible for the monetary authority to increase (or adjust) the nominal interest rate above the expected (or actual) inflation rate through contraction monetary policy. In this regard, the monetary authority can think of an alternative way by working on the expectations channel to reduce inflation

So thereby, after completing this study we have learnt that inflation, unemployment and growth trend are highly correlated. Authority cannot overlook factor individually. In our country inflation rate is highly relying on supply side and exchange rate. Inflation is

10
positively related with growth rate up to 7 percent after that it gets negative. In our country, labor factor cannot be counted so effectively to calculate inflation.

Bibliography:
Books:

1. D.G Lucket:

Money and Banking, McGrawhill, 3 r d edition 1984

th

2. Rudiger Dornbusch, Stanley Fischer & Richard Startz; Macroeconomics; 9 Edition. (United States of America: McGraw Hill Book Company, 2011-2012). Via Sources: 1. http://www.bb.org.bd 2. http://www.mol.gov.bd 3. http://www.economywatch.com