The Effects Of Inflation In Sri Lanka Economics Essay

Inflation means a sustained addition in the sum or general monetary value degree in an economic system. In Srilanka rising prices in is step by Colombo Consumers ‘ Price Index ( CCPI ) . Harmonizing to the diagram mean consumer monetary value index ( refer page -24- for the diagram ) we could see that from 1989 to 1990 the rising prices rate additions from 12 % – 21 % until 1991. However during the period of 1991 to 1995 the rising prices decreases by about 2.5 % .

The below diagram “ B ” ( mention page-24/25- ) shows the consumer monetary values. In 2003 the rising prices rate is about 9 per cent where in 2004 it has been decreased at the rate of about 7 per cent. However in the twelvemonth 2005 it has been decreased farther more at the rate of 5 per cent. From 2006 to 2007 the rising prices rate has been increased by 1 per cent during the period.

The CCPI recorded a 4.8 % addition on a twelvemonth on twelvemonth footing and a 3.4 % additions on one-year mean footing, the lowest and twelvemonth one-year norm rate recorded for a period of more than two decennaries. The diminution in rising prices in 2009 was eventful upon both the demand and supply factors. Monetary value additions in domestically produced goods, which on norm accounted for around 72 % of control monthly ingestion outgo in 2009, mostly impacted on rising prices during the twelvemonth.

The major part of rising prices came from the nutrient and non-alcoholic drinks sub-index, which has the highest weight of 46.7 % in the CCPI. The diminution in mean monetary values of certain domestic agricultural merchandise, particularly of rice, pulsations, veggies and coconuts, due to the addition in domestic supply conditions contributed to take down the monetary value force per unit area.

Price stableness, which refers to accomplishing and keeping a low and stable degree of rising prices, is the premier aim of many cardinal Bankss. In order to accomplish monetary value stableness, cardinal Bankss conduct pecuniary policy with a forward looking position as pecuniary policy actions affect rising prices with a clip of slowdown.

Inflation at the primary market degree as measured by the Wholesale Price Index ( WPI ) showed high volatility in 2009. On one-year mean footing, the whole sale monetary value index declined by 4.2 per cent as at terminal 2009.

( Beginning: – hypertext transfer protocol: // % 28new % 29/Note % 20on % 20CCPI_N_.pdf

hypertext transfer protocol: // % 28consumer_prices % 29.html )

Undertaking 2

Definition of rising prices

Causes of rising prices

( Approximately 500 words )

Inflation means a sustained addition in the sum or general monetary value degree in an economic system.

“ Inflation means that your money wo n’t purchase as much today as you couldA yesterday. ”

( Beginning: – hypertext transfer protocol: // )

The Keynesians View

Demand pull rising prices

Demand pull rising prices is initiated by an addition in aggregative demand. Keynesians have traditionally argued that rising prices occurs because of alterations in existent variable in the economic system. If aggregative demand exceeds aggregative supply, the monetary value degree will lift and therefore there will be rising prices. Harmonizing to the diagram “ degree Celsius ” on ( Page26 ) economic system is at full employment at income “ Yf ” . If there is a rise in aggregative demand the curve would switch from AD to AD1, it ‘s because consumer assurance additions, which raises independent consumer disbursement. Alternatively there might be a rise in export due to a strong economic growing in other states. The consequence of these additions in existent outgo in a rise in both end product and rising prices. Therefore end product rises from OA to OB whilst the monetary value degree rise from OE to OF. Rising end product will take to a autumn in unemployment.

Cost- push rising prices

If there is an addition in the costs of houses, so houses will go through this on to consumers. There will be a displacement to the left in the AS. Cost push rising prices would the 2nd Keynesians theory of rising prices. Cost-push rising prices is caused by alterations in the supply side of economic system, which increases the cost of production. The major beginnings of increased costs are: –

Wagess and wages

Imported goods

Net income push rising prices


1 ) Wagess and wages

If trades brotherhoods can show a common forepart so they can dicker for higher rewards, this will take to pay rising prices.

2 ) Imported goods

An addition in the monetary value of finished manufactured imports, will take straight to an addition in the monetary value degree. An addition in the monetary value of semi manufactured goods and natural stuffs will feed through indirectly via an addition in the monetary value of domestically produced goods.

3 ) Net income push rising prices

When houses push up monetary values to acquire higher rates of inflation.A

4 ) Taxs

Government can raise indirect revenue enhancement rates or cut down subsidies, therefore increasing monetary values.

The monetarist position

Monetarists argue that if the money supply rises faster than the rate of growing of national income so there will be rising prices. However if money supply additions in line with rising prices so there will be no rising prices.

Quantity theory of Money


M = Money Supply

V= Velocity of circulation

P= Price Level

T = Transactions

In the short tally, increases in “ M ” will feed through to higher degrees of dealing and autumn in “ V ” . This is known as the MONETARISTS TRANSMISSION MECHANISM. However in the long tally, with “ V ” invariable, addition in “ M ” over and above the rate of existent growing in the economic system ( the alteration in “ T ” ) will feed through to alterations in “ P ” .

Undertaking 3

Effectss of rising prices on: –

-Saves money

-Borrows money

-Lends money

( Approximately 500 words )

An person who keeps all his money in a box under his bed.

Inflation makes the value of money cut down. If an single decides to hive away money under the bed, the existent value of money would worsen over the period. When the money is withdrawn to utilize, it would purchase fewer goods and services compared with the clip it was foremost stored. However the existent impact on the loss of existent value of money stored depends on the extent of rising prices in the state over the period of clip. That is during hyper rising prices the impact on the person would be much worse than during times of crawling rising prices.

B ) Person who is borrowing money at the current rate of rising prices but who does non hold to pay this dorsum for a figure of old ages.

The borrower of a big amount of money who ‘s obliged to pay it pack after figure of old ages may derive as a consequence of addition in rising prices. Initially if the borrowed money would be of existent higher existent money compared to the clip it is traveling to be repaid due to the rising prices significant addition in rising prices. Every twelvemonth is likely to do the existent value of money to fall. However whether the borrower is favored during times of rising prices depends on whether or non the loaner charges an involvement. If the loaner chooses to bear down an involvement, the loaner may bear down an involvement from the borrower in order to counterbalance for the loss of money value, when the borrowed money is repaid. If the rising prices rate moves along with rising prices so the borrower experiences no alteration in his province of personal businesss. However if the involvement is set below the rising prices rate by the loaner due to hapless information handiness so the borrower is likely to derive. The existent rate of involvement falls as a consequence of rising prices there would be transportation of resources from the borrower to the loaner.

While the monetary value of money is considered the factor which decides the redistribution of benefits between the loaner and the borrower, it depends on the type of borrowing whether formal or informal. If the borrower obtains money from a comparative or friend it may be involvement free or he may be given an involvement allowance if the borrower has obtained a long term bank loan. Then the borrower possibly to a great extent taxed for rising prices. If the involvement rate is fixed over the period and there occurs unexpected rising prices. Then the borrower is likely to derive.

Person who has lent money out at the current rate of rising prices but will non be repaid for a figure of old ages.

The loaner as discussed in portion “ B ” at the same time loses if the borrower additions and wise versa as a loaner of money who expects it to be repaid after figure of old ages. His existent buying power diminutions after figure of old ages, when he ‘s repaid. He needs to accurately place expected rising prices over the adulthood period and repair an involvement rate equal to or above the expected rising prices rate. However if the involvement rates are placed high the external value of money may due the state would impart out less. This would cut down exports and do a bead in aggregative demand. Reduce in rising prices cause due to overheating. This will let the loaner to derive if he lends at a fixed involvement rate. However the grade depends on how effectual the state has been, over the past old ages in imparting out to the other states ( pvt loaning ) and is true for formal loaning such as bank loans.

Undertaking 4

Reasons for undertaking rising prices

Redress for different types of rising prices

( Approximately 500 words )

The authorities may desire to undertake rising prices because it tends to redistribute income in favour of those with stronger bargaining powers and debitors and penalizes those with weaker bargaining power, creditors. It may besides take to impairment in the balance of payment. An addition in the rising prices would take workers and houses to raise rewards and monetary values by sum which takes into history in the yesteryear, nowadays and besides when future monetary value additions.

B )


Decisions made by the authorities on its outgo, revenue enhancement and adoption would be a financial policy. This may be implemented to cut down rising prices originating from a assortment of causes.

Demand pull rising prices

At full employment a authorities can use deflationary financial policy. This will affect raising revenue enhancement. Increasing income revenue enhancement will be probably to take down consumer disbursement, cut downing authorities disbursement will take down aggregative demand and raising in corporation revenue enhancement will be given to lower investings in a state. A decrease in all of these constituents of aggregative demand will hold a downward multiplier consequence and may win in taking an inflationary spread.

Increase in income revenue enhancement may do monetary value to lift if it stimulate workers to press for pay rises to keep their existent disposable income. Disposable income is the income that families have to give to ingestion and economy, taking into history payments of direct revenue enhancements and transportation payments. It may turn out hard to cut authorities disbursement and cut downing public and private sector investing will take down future possible out put.

Cost push rising prices

Fiscal policy steps includes cut downing indirect revenue enhancement, cutting income revenue enhancement in effort to lower pay claim, cut downing the monetary value charged by authorities concerns, subsidising production costs and take downing pay rises in the populace sector.

Monetary rising prices

Lowering outgo by more than the revenue enhancement gross is a financial policy attack which might besides be adopted if the cause of rising prices is thought to be the money supply turning faster than the out put due of authorities adoption.


Deflationary pecuniary policy may besides be employed against demand pull rising prices. Rising in involvement rates will be probably to take down investing and cut down consumer disbursement, on lodging and other points bought on recognition. However the addition in involvement rate depends really much province on consumer outlooks.

Cardinal Bankss may seek to cut down rising prices by promoting a rise in the exchange rate. A higher exchange rate can cut down rising prices in three chief ways. It lowers the imported finished goods which count in the RPI and cut down the costs of natural stuffs which have been imported. A high exchange rate can hold an inauspicious consequence on employment and economic growing. A fixed exchange rate besides can be used as an anti-inflationary step.

The chief of an income policy, introduced to cut down rising prices, is to associate the growing of incomes to the growing of productiveness so as the prevent the inordinate rises in factor incomes which raise cost and hence monetary value. Price controls stop lifting monetary values. However, attacks the symptoms of rising prices instead than causes. Where the cause of rising prices is extra demand, monetary value controls will take to make a demand for a system of rationing.

Undertaking 5

Supply side economic system

( Approximately 500 words )

Supply side policy is a scope of steps intended to hold a direct impact on aggregative supply and specifically the possible capacity end product of the economic system.

Supply side policy in UK

Since 1979 the authorities has been committed to implementing supply side policies aimed at bettering the workings of free markets. A broad scope of steps have been introduced as followers: –

The labor market

Help to concern

Goods market

The labor market

Trade brotherhood power

The power of trades brotherhoods has fallen because of Torahs doing it more hard for brotherhoods to run. Equally good as supply side policies, the diminution of fabrication industries reduced the influence of trades in many industries like coal and steel… There are now fewer yearss lost to work stoppages and pay rising prices has non been a job like in the seventiess. However many workers are less protected and may acquire lower rewards taking to greater inequality.

In 1971, the conservative authorities under Edward wellness passed the industrial dealingss act which effort to important trade powers. However the statute law was flawed and trade brotherhoods circumvented the commissariats of the act. The labour authorities of 1974-79, if anything, increased the power of trade brotherhoods by revoking the industrial dealingss act and giving brotherhoods further rights.

Wage bargaining

Supply side economic experts view corporate bargaining as an inflexible manner of honoring workers. They advocate single wage bargaining with payment system base on fillip related wage. The authorities in the 1980s and early 1990s went some manner to interrupting corporate bargaining. It encouraged employers to travel from national wage bargaining to local wage bargaining. In the populace sector, it attempted to travel off from national wage understandings to local 1s.

State public assistance benefits

In 1979 the authorities abolished net incomes related unemployment benefits and besides abolished the index linking of benefits to the rise in mean net incomes. In 1988 in a major inspection and repair of societal security system, the job of both the poorness trap and unemployment trap, where addressed by increasing benefits paid to those in low paid work and edged benefit rates to those non in a occupation. In other move, the authorities initiated the restart programme in 1986, which forced any workers claiming benefits for being out of work to go to an interview at a jobcentre at least one time a twelvemonth to reexamine his/her ownership. Employers alternatively of subtracting revenue enhancement from an employee credited the low paid worker with the excess money. Efficaciously, it is a benefit paid through the wage package.

Fringy revenue enhancement rates

After 1979, cutting revenue enhancements ( direct ) was high on the lists of authorities precedences. In the 1980s income revenue enhancement was cut particularly for the better off. The top rate of income revenue enhancement fell from 60 % to 40 % . Overall the revenue enhancement load has non fallen because the authorities has addition indirect revenue enhancements such as VAT.

Help to concern

If aggregative supply is to increase, the private sector demands to spread out. Hence, harmonizing to the supply side economic experts, the authorities needs to make an environment in which concern can boom.

Tax privilege for salvaging

The revenue enhancement system in the UK has traditionally favored groups salvaging strategies, such as pension and confidence policy.

Aid to little concerns

Small concern are of import in the economic system due they provide new occupations. Conservative authorities between 1979 and 1997 placed peculiar importance on the development of an ‘enterprise civilization ‘ . Income revenue enhancements were reduced and in little company net incomes revenue enhancements have been cut, and besides investors in little concern were given revenue enhancement interruptions, whilst the unemployed were encouraged to put up in concern on their ain through the proviso of grants. The authorities besides attempts to cut down the administrative load on little concern by cutting ‘red tape ‘ although this was contrary to the ever-increasing sum of statute law that concern have to follow with in Fieldss such as employment and consumer protection.

Deregulated Fiscal Markets

The authorities has deregulated the fiscal services market, for illustration edifice societies can move like Bankss, and more establishments can now offer mortgages, this led to more competition and lower adoption costs. However, the recognition crunch of 2008-09, illustrated the job of less regulated fiscal markets.

3. Goods markets


There has been an extended denationalization run, most of the major public-service corporations such as Gas, Water and Electricity were sold by the authorities and floated on the stock market. In some industries like telecommunications it has led to more competition, lower monetary values and better quality of service. However it has been hard to present competition into the H2O industry. Rail Privatization has been unsuccessful with the authorities holding to efficaciously renationalize the railroads.

Encouragement of international free trade

Fierce foreign competition consequences in a domestic industry which has to be efficient in order to last. Since 1979, authoritiess have tended to recommend policies for free trade on most issues.

( Beginning: – hypertext transfer protocol: // )

Supply side policy in U.S.A

“ Supply Side Economics ” was applied to the statement that lower revenue enhancement rates would better private sector inducements, taking to higher employment, productiveness, and end product in the US economic system. Taxes enter many determinations, but the two most of import are likely that they discourage work, since they lower the after revenue enhancement return from work, and they discourage salvaging and investing, since they lower after revenue enhancement returns.

A lower revenue enhancement rate on pay income should increase the labour supply. Given the labour demand map, this addition in labour supply will increase employment, cut down the pre-tax existent pay and increase the post-tax existent pay.

Lower revenue enhancements on involvement and capital additions, every bit good as tax-sheltered salvaging programs like IRAs and 401 ( K ) plans, to do salvaging more attractive and lead to an addition in nest eggs. In equilibrium, this will take down existent rates of involvement as more economy flows into capital markets, and raise investing. Over clip this investing leads to higher capital, more productive labour, and higher end product and rewards.

Furthermore, the 1980s revenue enhancement cuts did non increase the rate of growing of GDP and productiveness, nor the investing and nest eggs rates in 1980s the private economy continued to worsen and besides in the 1973-1980, private salvaging averaged 7.8 per centum of the economic system, and dropped to 6.9 % in 1986 and 4.8 % in 1989. In other words, the salvaging rate was significantly lower after the 1981 revenue enhancement cut than before it. Over the period of 1982-89 the labour productiveness grew at the mean rate of 1.6 % .after 1973, the one-year growing rate of productiveness has been really near to 1.1 per centum. It mean about 1.1 per centum besides in the 1980s.Budget shortages that were equal to 40b US $ in 1979 ( -1.7 % of GDP ) and 74b US $ in 1980 ( -2.7 % of GDP ) increased to 221b US $ by 1986 ( 5.2 % of GDP ) , and besides in 19879 the GDP ratio was 26.1 % , and increased to 41.2 % in 1986.