INTRODUCTION TO INFLATION

Introduction to Inflation

What is inflation?

​The rate at which the price of goods and services rise over a given period of time is referred to as inflation.
Inflation has a major effect on the economy of a country or can even impact the life of individuals on a daily basis.

Causes of Inflation

1. Increase money supply unaccompanied by proportionate increase in the output of goods and services.
2. Increase in government expenditure.
3. Abnormal speculation and hoarding goods to create artificial shortages hence raising prices of goods.
4. Uncontrolled increase in costs of productions.
5. Increase in profit margin.
6. Reduction in subsidy.

Measures Governments put in place to combat/control inflation

​a) Monetary policy
This is a deliberate move by the government through the central bank to regulate and control the money supply in the economy which may lead to demand price inflation. The policies include:

1. Increase rate of interest of lending to the commercial banks. This forces them to increase the rate at which they are lending to their customers. to reduce the number of customers borrowing money. reducing the amount of money being added to the economy
2. Selling of government securities in an open market operation (o.m.o). The selling of securities such as Bonds and Treasury bills mops money from the economy. reducing the amount of money being held by individuals
3. Increasing the commercial banks cash/liquidity ratio. This reduces their ability to lend and release more money into the economy. reducing their customers' purchasing power
4. Increasing the compulsory deposits by the commercial banks with the central banks. This reduces their lending power to their customers. which makes their customers to receive only little amount from them. reducing the amount of money in the economy
5. Putting in place the selective credit control measures. The central bank may instruct the commercial bank to only lend money to a given sector of the economy which needs it most, to reduce the amount of money reaching the economy
6. Directives from the central banks to the commercial banks to increase their interest on the money being borrowed. to reduce their lending rates
7. Request by the central bank to the commercial banks (the moral persuasion) to exercise control on their lending rates to help them curb inflation. 

b) Fiscal policy
These are the measures taken by the government to influence the level of demand in the economy through taxation process. They include

1. Reduced government spending. This reduces the amount of money reaching the consumers. Which is likely to increase their purchasing powers leading to inflation
2. Increasing income taxes. This reduces the level of the consumer’s disposable income and lowering their spending levels. reducing the inflation
3. Reducing taxes on production. This reduces the cost of production. lowering the prices of goods reaching the market
4. Subsidizing the production. This reduces the cost of production in the economy, which in turn passes over the benefits to the consumers inform of reduced prices.
5. Producing commodities that are in short supply. This increases their availability to meet their existing demand in the market, controlling demand pull inflation

c) Statutory Measures
These are laws made by the government to help in controlling the inflation. They include:

1. Controlling wages and salaries. This reduces the pressure put on the employers to meet high cost of labor for their production which in turn is just likely to lead to cost push inflation. It also minimizes the amount reaching the consumers as their income, to control their purchasing power and the level of demand. controlling the demand pull inflation
2. Price controls. This reduces the manufactures ability to fix their prices beyond a given level which may cause inflation due to their desire to receive high profits.
3. Restrictive imports. This reduces the chances of high prices of imported goods impacting on the prices of the goods in the country (imported inflation) and making the manufactures to look for alternative source of raw materials for their production
4. Restricting the tennis of hire purchase and credit terms of sales. This reduces the level of demand for those particular commodities in the economy which if not controlled may lead to demand pull inflation
5. Controlling exports. This ensures that the goods available in the local market are adequate for their normal demand, Shortage of supply of goods in the market is likely to bring about the demand pull inflation

Sampled KNEC KCSE Questions & Answers

1. 2006 Q20 P1
   State four factors that may cause inflation in an economy (4 marks)
2. 2008 Q21 P1
   Outline four measures that a government may put in place to reduce high inflation in a country.  (4 marks)
3. 2009 Q14 P1  
   Country x has been experiencing an upward trend in the price of petrol as a result of a rise in inflation. State four steps that can be taken to minimize expenditure on this (4 marks)

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