INTERDISCIPLINARY JOURNAL OF CONTEMPORARY RESEARCH IN BUSINESS

 INTERDISCIPLINARY JOURNAL OF CONTEMPORARY RESEARCH IN BUSINESS
Institute of Interdisciplinary Business Research 398
DECEMBER 2011
VOL 3, NO 8
The Impact of money supply on Inflation in Pakistan
Principal Author/Corresponding Author
Sajjad Gul
 Sarhad University of Science and Information technology, 36 B, Chinar Road University
Town, Peshawar, Khyber PukhtoonKhwa, Pakistan
 Co-Author/Corresponding
Hassan Iqbal
 Sarhad University of Science and Information Technology, 36 B, Chinar Road University
Town, Peshawar, Khyber PukhtoonKhwa, Pakistan
Abstract
This paper focuses on Impact of money supply on Inflation in Pakistan. Literature is cited
related to inflation and to support hypothesis. Data relted to inflation is also used to support
the hypothesis. On the basis of data , summary and conclusion is given.
Keywords: Impact ; Money supply ; Inflation in Pakistan
1. Introduction
Inflation and money supply which are two indicators of economic development and govt.
Authorities had always given great importance to these two important issues regarding
development of economy of our country due to which our country remained low inflationary
country since three decades after independence than it crossed its single digit inflation rate in
1970’s but reduced to single digit inflation in 1990’s because of the affect of international
reserves on money supply and flexible exchange rate was also helpful in this regard.
 During the first seven years, i.e. from 1990 – 97 it remained persisted as an average at 11.4%
due to lower investment and slower growth, increase in prices of food items, raw materials,
inflationary expectations, increase in direct taxes, excess money supply, supply shocks,
damage to crops due to unexpected dry weather, heavy rains, floods and etc while the efforts
were made to keep money supply close to the growth of GDP and moderate the currency
depreciation. But monetary policy was geared in coordination with achievement of twin
objectives of macro economic stability with sustained economic growth and determining
interest rate structure by free market forces. The rate of inflation declined in 1998 to 7.8%.
Further it declined to 5.5% in 1999. Moreover in 2000 it was too much lower i.e. 3.4%. Most
important causes for declining of inflation rate were the growth of money supply to some
specific extant i.e. higher agricultural growth, easy supply and depressed international
market.
The lower inflation rate more declined to 3.1% in 2002 – 04 but the rate than rose to 4.4% in
2006 and in 2007 rate of inflation reaches too much level, i.e. 9.3% against 4.4% in the
previous year i.e. 2006. The factors for this rise in inflationary trend are the same i.e. due to
supply shocks, demand pressures, rising level of incomes. To control the inflationary rate and
to bring it with respect to the adequate money supply govt. took various measures. For the
purpose SBP tightened its monetary policy from an easy monetary policy to strict policy.
Lending rates has risen to 152 basis points and thus controlling the liquidity amount in this
system.
The above information regarding inflation and money supply clearly indicates the situation of
our economy. In the light of this information regarding the important issues of our economic
development, objectives, hypothesis, and organization of the study are being discussed
below.
1.1 OBJECTIVES OF STUDY
The objective of study is to analyze inflation and money supply situation in Pakistan. This
includes:
To review inflation and money supply situation in Pakistan
To analyze present conditions
To suggest policy measures for controlling the problem of inflation and money supply in
Pakistan.
1.2 HYPOTHESIS OF STUDY
Hypothesis of the study is that money supply negatively affects inflationary trend in Pakistan.
2. LITERATURE REVIEW
Pakistan is an under developed country and it tried its best to develop it while money supply
and inflation both are most important aspects of its economy and requires deepest attention
from authorities. Different writers/authors give their views regarding these important issues
of a country’s economy in different periods of time. Mostly they all agreed about these issues
of money supply and inflation that money supply is that amount of money which circulates in
an economy while inflation is describe as a persistent rise in price level in a country. They
both correlated with each other in such a way that any change in money supply brings change
in inflation rate and vice versa.
 Different views regarding these issues of money supply and inflation given by different
authors are being discussed below.
Author : William J. Baumol, Alan S. Blinder Book: Economics; Principle and Policy
Published: 2005 Publisher: Thomsan South-western
William and Alan noted about inflation that it is an increase in general level of an economy’s
prices which change the distribution of an economy’s level of production by reducing
purchasing power of individuals and other economic units with fixed money incomes. It
affects nature of production in the sense that it becomes a cause of an increase in the purchase
of and production of those things whose prices raise the inflation. It reduces the purchase of
financial assets i.e. bonds. Inflation also reduces saving levels. Moreover inflation changes
the nature of production of one economy become more expansive for the person in that
economy while it is available in some other economics at low price and less expansive
obviously he will move to other economies.
Author : James Anthony Trevithick Book: Inflation A Guide to the crises in Economics
Published: 1980 Publisher: Penguin Page: 132
As a whole according to Alec & Alexander major causes of inflation are monopolist and
labor unions whose policies affect price level and thus cause inflation. Monopolists by
exploiting consumers raise the prices of their specific product while labor unions insist on
increasing wage level while production or supply of product remains same. Flow of money
supply increases which raise the level of inflation rate but in this way if fiscal policies are
used properly the evil can be controlled.
Publisher: Manchester University Press Page: 234
Michael & George developed the idea about money supply that concept of money as the
stock or supply is important to individuals, to businessmen, to business firms and to the
economy as whole. The rate with which money supply through economy is also important
because it may affect the pace of economic activity in any given period of time but still there
is no permanent definition of money supply. So define it different types of financial assets
have come to be accepted as part of definition. The assets are of a type which includes
checking accounts at banks and saving and loan association. M1 is the most important
measure of money supply consists of checking deposits at commercial banks. Therefore
regarding money supply of any nation we cannot ignore the importance of business of
banking.
Author : Roger LeRoy Miller Book: Economics Today Published: 2000 Publisher Addison-
Weslay Page : 159
Roger Miller point out 10 clear signs of inflation presence. First of all individual itself is the
cause of inflation and proves inflation. In securities business prices will continue to rise as
long as new buyers. Keep coming to market inflation reached its peak. Market in securities
business is not different from market for expectation of inflation and related activities. 2nd
sign of peak inflation is the speculation. 3rd sign of inflation is the amount of money which
has been borrowed for speculation purposes. Borrowed money can inflate prices to a
dangerous level. 4th sign of inflation can be seen when the price advance of an investment has
reached a ridiculous proportion. 5th sign of inflation is that when investment has been taken
out of an asset and gives all the importance to speculative element. 6th sign of inflation is to
look at trading volume in most speculative investment vehicles which has risen dramatically
to record level. 7th important sign accordingly to which there has been a frantic search for
new speculation. 8th sign about peak inflation said that when an attempt has been made to
revive the old favorites despite an obvious deterioration in the fundamentals. 9th sign shows
inflation can be seen by market action. By having a glance on major commodities index we
get information about inflation peak. Last sign i.e. 10th sign of inflation presence is that
conviction that inflation rate expected to continue for a long time.
Author : Milton Friedman Book: Inflation and unemployment Published: 1993 Publisher:
Institute of Economic Affairs
Friedman (1986) while discussing about money supply and inflation said that money should
not be confused with credit. He said that under the principle of reflux (debt repayment)
money supply and its growth is a function of demand for credit. Sudden rise in credit demand
leads to one in money growth but sudden and temporary increase in money supply may be
removed by debt repayment while talking about inflation he said that both are correlated i.e.
money supply and inflation and this correlation among money supply and inflation is an
important thing. In closed economy sum of real rate of interest and uniform inflation rate will
equal to the growth rate of the stock of money and equilibrium rate of inflation is
undetermined. Purchasing power of a unit of money must yield some interest rate otherwise it
will be not guaranteed. Monetary equilibrium thus must contain some sort of quantity theory
of money or better prices otherwise if growth rate is less than inflation rate the real stock of
money would decline until it do not exist longer.
Author : Frank Northen Magill, Demos Vardiabasis Book: Inflation and Money Supply
Published: 1991 Publisher: Salem Press Page: 59
Franks and Demos (1991) concluded that controlling of money supply is an important way of controlling of total demand level in the economy. Monetarist government in particularly give
it more importance and they choose the way of measuring money supply that suits them best.
For example, if they believe that only few items should be selected they choose a narrow
measure as Mo but if a lot of items are included then a broad measure is selected i.e. M3. On
the other side different ways to control inflation rate are the use of monetary and fiscal
policies which affect the level of demand in economy by having a cut in money supply or the
reduce rate at which it is increased and a reduction in government spending, increase in tax
action will reduce total demand. Also by the use of exchange rate it is possible for the govt. to
influence the rate of inflation as higher exchange rate will reduce the inflation rate because
import prices will be lower and export prices will be higher therefore demand for exports will
be lower. This will reduce that total demand in economy and thus inflation will be reduced.



Author : Gottfried Haberier Book: Inflation and its Causes Published: 1966 Publisher:
American Enterprise Page: 127
M Winzer (2002) concluded that unstable macro economy is due to inflation which occurs
mostly due to budget deficits. When to settledown budget deficits notes are printed and
foreign and domestic borrowings are taken into account but in those efforts there is a high
rate of inflation and unstable economy therefore, great care is required from the side of govt.
authorities in the way that when money is supplied in any economy proper import-export
policy, control on the supply of commodities, allocating scarce resources properly, fiscal
policies and especially monetary policies to be adopted.
Berglas School of Economics, Aviv University, Center for Economic Research, Book, Review
of inflation Bias Date; May 2003
Mallik and Chowdhury (2003) conducted co integrated analysis of inflation on economic
growth for four South Asian countries Bangladesh, India, Pakistan and SriLanka and report
two interest points. First, inflation and economic growth are positively related. Second, the
sensitivity of inflation to changes in growth rates is larger than that of growth to change in
inflation rates.
Author: Don Paalbarg Book: Analysis and history of inflation Publisher: Praeger Publishers
(December 30, 1992) Language: English
Don Paalbarg discussed money supply that it is determined by commercial banks, public and
central bank. To know about money supply we will have to consider the joint behavior of
public commercial banks and central bank. He said that commercial banks borrows from
public and central bank and give it to public in the form of loans and lend it to investors and
govt. But when commercial banks lend they do not advance all of their resources, they keep a
certain percentage of time and demand deposits. This percentage plays an important role in
the determination of supply of money.