Inflation and the UK Economy - Example

RESEARCH INFLATION AND THE UK ECONOMY Introduction This research is generally done on the basis of a newspaper article on BBC news, d 18th June 2013 titled as “Economic tracker, inflation”. This article mainly focused on the concept of U.K‘s inflation rand its fluctuation rate in the economy and its effects on different sectors. The devastating threats the economy faces and the outcomes of it. The discussion should be mainly concentrated on the nature, cause and its impact of inflation in U.K’S economy and what remedies should be proposed thereon for the abatement of these threats. UK and Inflation Inflation is a global phenomenon and the process of persistent of rise in prices goods and services and gradually the purchasing power are falling It is the perfect epitome of the case where there arises a dilemma as the opposite forces are working, i.e. the value of money is ebbing and the prices are constantly steeping high(cost-push inflation). There arises a remarkable gap between the demand and the supply of goods and services (demand-pull inflation). The gap between the goods and services price inflation has been widened in the United Kingdoms over the last decades which can be a real threat the economy concern. The offsetting of goods price deflation in the economy accompanied by an elevated inflation rate dominated in the U.K economy. According to the recent reports it has been seen that U.K’s cost-pull inflation rose to 2.7% in May, up from 2.4% in April. It should be keenly noted on this April that Consumer Price Index (CPI) had fall for the first time since September 2012.Airfares rose to 22% in the phase of April-May due to an aggrandizement of inflation rate in this period. The rate of Retail Price Index (RPI) which rose to 3.1% from may to 2.9% in April this year. Inflation rate is the hike in price rate, i.e., Comparison of the current year’s rate with the base year’s rate and hence we see the fluctuation and thus this concept is applied dynamically in U.K’s economy and it was very much noticeable that the cost of living was high for this effect. There have been dramatic changes which can be apprehended in the recent year’s trends. In 2008, it can be seen that due to the initialization of global financial crisis, prices were rising at a yearly rate of 5%.According to CPI measure, less than a year later prices were rising by 1% and falling by about RPI measure on the other hand (Economic Tracker, Inflation, June 18, 2013). Causes Increase in private and public expenditure, increase in consumer spending, reduction in taxes, repayment of old internal loans, growth in population, increase in exports and deficit financing are the main causes in rise in demands for gods and services. Industrial disputes, shortage of factors of production, natural calamities and hoarding of goods are considered to be the main causes of decrease in the supply of goods and services. This phenomenon of inflation incorporated in the U.K’s economy was really a big swing that really caused some transformation within the country. The transportation cause was high due to interpolation of high oil prices resulting into upraised prices of products and thus high household energy bills. Food prices were enormously high due to the rise in subsequent rise in oil prices, which makes fertilizer and power much more expensive and costlier. The other causes are droughts, rising demand from emerging economies, and land being used for bio-fuel. The cost of imported goods bounced up due to the fall in sterling. By the early 2009, the price of crude oil has collapsed in just six months as it loosed two-thirds of its value. The world-wide recession had taken hold, which implies that there was less demand for fuel to power factories, transport good for the availability of shopping and to get the staff and worker to work. In the UK’s , another major reason for the inflation rate to be lower in-between the phase of 2008-09 was carving of VAT from 17.5% to 15% that was introduced to shoot up spending. The RPI measure was remarkably marked with negative housing cost due to the successive abatement of interest rates and thus implying lower mortgage rates for many peoples. But the inflation rates were seen for a limited period in the economy. The rate of VAT was in the zone of getting the previous shape being back with a rate up to 17.5% at the beginning of the year 2010 and then inflated to 20% in the following year in the economy. (Economic Tracker, Inflation, June 18, 2013). The inflation rate is explained with the help of AS-AD (Aggregate demand-Aggregate supply model) by John Maynard Keynes below: Price Level LRAS SRAS P0 AD Q0 Real GDP, Q Shifts in AD-AS Model Here the two factors mainly working in the economy, i.e. the Cost-push inflation and the Demand-pull inflation (remedies factors for hiked price level marked with a high supply and lower demand level).The Cost-push inflation is generally there to lower the aggregate supply(short run) and the Demand-pull inflation is mainly to increase the level of demand in the economy. The Short-run supply curve (SRAS) decreases and hence contacts. The AD curve shift rightward and hence resulting in expansionary gap results. A three-tier impact really works here, i.e. AD, SRAS AND LRAS. In extreme demand pull inflation: AD increases, SRAS decreased by the same amount and LRAS remains constant and hence increasing the price level but the real GDP remains unaltered at the full employment level of real GDP. It is graphically explained above. Aggregate Expenditure is a result of consumption, investment, government purchases, and net export. The consumption decreases as the prices range is higher in the economy, hence investment is low as less money concentrated in the hands of income earner to hike in price and reduction of money level in people’s hand. The Government purchase is also low due as money supply less in the hands of an individual people are not able to pay a good amount of taxed and thus export minus import that is the trade balance is also low, thus a threat to the economy.(Evans, December 18 2012) Impact on the economy Economic impact If the economy is deeply affected by inflation, the economic impact can be sub-divided into two major parts, i.e. its impact on productivity and impact on distribution of wealth. If the inflation creeps in the economy it has a positive impact as the price level increment is small.The cost of production increases at a small rate and as a result a lower rate profit can be noticed which creates a positive effect on the economy. But in the case of hyper-inflation negative impact is created on the level of production, therefore the economy faces a stagnated growth thereon. It will disrupt the price system which will slowly increase and thus there would be no mobilization of the factors in a proper way. It not only discourage the saving of domestic capital but also results in devaluation of money, discourages foreign investors as there will be no profit for the foreign investors. High rate of inflation does not help in capital formulation, saving goes low and reduction of capital accumulation. It encourages hoarding and speculative activities and reduces the amount of production as due to low saving there is insufficient capital formulation and due to uncertain business it is not possible to take risk and hence lower volume of production. Inflation also changes the pattern of production. Due to increased inflation people with increased income will demand for luxury commodities in a greater amount and thus the demand and hence the production of necessary commodities shatters. The quality gets decreased as inflation is faced by the sellers in the market, and to earn huge profit, the quality suffers from a continuous threat. Inflation has also impact on the distribution of wealth, which is mostly negative as the price rises in the economy, i.e. Money gets concentrated in the hands of few. There are two types of income earners in the economy. One is fixed income the earning group and the other is variable income earning group. If the inflation survives in the economy for a long gesture then the rich will be richer and the poor will be poorer (businessman wins and the serviceman looses).When price increases the debtor gets benefitted and the creditor looses. Farmers generally get benefitted (excluding the small farmers) (Rothbard.n.d). The Philips curve shows the relationship between the unemployment and the inflation in an economy. As we know that inflation is the rise in the level of prices of goods and services and a correspondingly the money level is low in the economy. If there is low inflation rate then the average prices of goods and services cannot be elevated to a much higher level. Unemployment on the other hand arises because people are actively searching for job at a wage level but there is no job actually available in the market. New Zealand economist William Philips propounded a theory on 1998 by gathering the unemployment data and making a keen note on the changes in level of wages in UK from 1861 to 1957. According to him one stable curve shows the trade off between inflation and the unemployment and it can be noted that they are inversely or negatively noted. They act in an opposite direction, i.e. If unemployment goes down, the rate of inflation increases in the economy. The Philips curve (the natural rate of unemployment hypothesis) can be seen in both long and short run. The graph is as follows: Wage inflation against unemployment If the economy is in recession the level of unemployment will be fairly high which imply surplus labour in the economy. When the economy started growing, the AD curve gets increased resulting in rise in the level of employment. In the beginning there will be little pressure for the wages to rise but as there are more employment generation with faster economic growth, the wage will start rising slowly and hence increasing the firms cost of production and thus the customers faces a higher price burden. Therefore we can conclude that decrease in unemployment leads to increase in inflation and so on. There can be money illusion effect as they thought the real wage to be the increased wages offered to them. They don’t really focus on the original fact that increased wage is accompanied by increased prices thus creating a frictional unemployment. It was the short-run phenomenon that was discussed above but in long run since unemployment always returns to its natural rate and hence there is no such trade-off. If there exists a condition that unemployment is below the natural rate, the GDP exceeds the potential output and hence economy’s self correcting tool will create inflation) and on the other hand if the unemployment rate is above the natural rate, GDP is below the potential output (price level will fact a downward pressure from the self correcting tool or mechanism). The Philips curve is downward sloping and negative in nature and this phase is also called “stagflation” as both the stagnant economy and rise in inflation occurring simultaneously (Frisch, 1983, p. 44). Political and other factors Due to excessive increase in demand during the time of inflation, the employment and production also increases, though the debtors, producers and businessman gains does not always mean that that there is always a good effect of the inflation as it harms the investors, creditors and consumer. Beside there are many non economic effect such as which implies a negative effect on social and political and also the moral impacts. The economy could be considered to be running in a slower pace, if it passes through severe level of corruption such as bribery and implication and domination of black economy. It can be socially, morally and well as politically stagnated due to such problems. Some of the Social, moral and political Effects are as follows: The political effect implies that during the period of inflation the people will be highly unsatisfied with the government role and the polity can be effected which should be keenly noted. Competition does not rule out to be healthy as the opponent party always try to dominate the other party to become the ruler by criticizing the other party and thus try to divert the mind of the government which is really a bad practice. It also creates some social impact of converting the rich to richer and the poor to poorer and thus a mode of conflict start between both the classes. The moral impact is as follows. It leads to creation f black economy (way of earning profit in a wrong way).People takes bribes to fulfill their need of making high profit and thus uses speculative ways to deal with it which really creates a negative effect on the morality of mankind (Jain and Khanna, 2009-10, p. 306). Recommended policies to correct Inflation There are three side policies. Demand side, Supply side and exchange rate policies to check for inflation. The demand side policy can be two types of fiscal policy such as deflationary fiscal policy (increase in taxes and lowering of government spending) and deflationary monetary policy (rising of interest rate and reducing money supply). Supply side policies involve all the policies involved in improving the efficient supply of all goods and services including privatization, training and education given to workforce, increase in industry competition.(Carlson and Parkin,1978, p.128) Conclusion Inflation is really a high threat for the economy. Money should be channelized in such a way that the price level should be proper along with the level of money circulation in the economy. All the economic sectors should be properly synchronized so that the probability of the economy to face this inflation should be minimized. Government policies along with every individual attention (businessman, service man and rest all sectors) of the economy should be careful in every way possible. Proper monetary and fiscal policy should be implemented wherever necessary. Wealth should be distributed in the hands of all to face the ever-changing growth in this era of globalization. REFERENCES 1. Economy Tracker: Inflation (June 18, 2013), BBC News, available at: http://www.bbc.co.uk/news/10612209 (accessed on June 29, 2013) 2. Evans, A. J, (December 18, 2012), A (simplified) dynamic AD-AS model, available at: 3. http://econ.anthonyjevans.com/2012/09/a-simplified-dynamic-ad-as-model/ (accessed on June 29, 2013) 4. Frisch, H. (1983), Business & Economics, Cambridge University Press, 1983 5. Jain, T R, and Khanna, O P (2010), Macro economic Analysis, Rahul Jain (v k India enterprise), 2010 6. Parkin, M. and Michael,T. (1998) Inflation in the United Kingdom, Manchester University Press 7. Rothbar, M. N, (n.d), Government Meddling with Money, available at: http://mises.org/money/3s2.asp (accessed on June 29, 2013) Read More