Circumstances under which inflation may be desirable in an economy.

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Circumstances under which inflation may be desirable in an economy.

Note : Here we derive the points from the merits of inflation or positive effects and since we are focusing on circumstances, the points must be presented in a conditional tense i.e. by use of when in case, during period of etc.

When it stimulates economic growth. Rising prices during the times of inflation increase profit levels which increases profit level which increases investment, production, output and economic growth. OR The existence of mild inflation encourages producers to increase output in order to sell more goods and services to make higher profits.

This increases output brings about economic growth.

When it promotes investment and production in the country. Rising prices increase profit levels which encourages investment and production in the country.
When it leads to an increase in employment in the country. This comes about as a result of increase in investment during the time of inflation.
Rising prices increase the cost of living and this forces people who would not have taken up jobs to get into active employment because they need to earn income to survive amidst the high cost of living.
When it helps an economy to overcome a depression. This is because the increase in prices leads to increase in income and aggregate demand which lifts the economy out of a depression.
When it stimulates aggregate demand/ expandmarket. Rising prices lead to an increase in income which increases aggregate demand.
When it encourages labor mobility. Due to inflation, workers shift from low paying jobs to high paying jobs this gives rise to occupational mobility of labour.
When it promotes forced savings. During a time of inflation, people are forced to forego consumption of some of the commodities that they have been purchasing.
When it encourages hard work/ when it stimulates innovations and inventions. During periods of inflation, the cost of living rises, this makes the public to be creative and hard working so as to receive money and able to survive amidst the inflation.

The people are encouraged to work hard to get money in order to buy those goods whose prices are rising slowly.
When it promotes utilization of resources. Rising prices encourage investments which leads to an increase in production and expectation of resources.
When it benefits the borrowers in real terms. At the time of borrowing, money has a higher value. The borrower uses the money to buy more goods from the market. However, by the time the borrower pays back the money, its value is lower but he has already gained in real terms.

Objectives of fighting inflation/Reasons for keeping a low Rate of Inflation/why Government strives to keep a low rate of inflation/ Why Government control inflation.

To promote savings among people. The government controls inflation to ensure stable prices in order to enable people gain confidence in the currency which encourages saving.
To reduce unemployment .the government strives to keep a low rate of inflation to ensure stable prices which results into stable costs of production and thus reducing closure of firms hence reducing unemployment.
To promote people’s confidence in the local currency. The government strives to keep a low rate of inflation to ensure prices in order to enable the country’s currency to gain value hence promoting confidence in the currency.
To enable the fixed income earners to enjoy a better standard of living
To encourage lending by financial institutions
To reduce brain drain.
To reduce income inequality.
To improve the B.O.P Position.
To encourage and promote production of high quality goods.
To encourage local and foreign investors.
To reduce industrial unrest.
To discourage illegal activities for example bribery and smuggling of goods
to encourage local and foreign investors.
To ease or facilitate economic development planning.
To make the government in power popular among the public.
To maintain a low cost of living and ensure that people are not over strained.

Questions

1a) What is meant by the term stagflation..

b) Under what circumstances may inflation be desirable in an economy.

2a) Why may inflation be desirable in an economy.

b)Why may a low rate of inflation be desired in Uganda.

3a) Why may a high rate of inflation be undesirable in an economy.

Policy Measures for Controlling Inflation in Uganda

Increase direct taxes/ taxes on incomes. This reduces the disposable income which reduces aggregate demand and hence preventing prices from rising. OR By increasing direct taxes, there is a reduction in disposable incomes of people which reduces aggregate demand and hence controlling inflation.

Control issuance of the country’s currency. This controls the amount of money in circulation which controls aggregate demand and thus preventing prices of goods and services from rising further.
Reduce government expenditure,. This reduces the money supply which also reduces aggregate demand and thus controlling inflation.
Improve/ Develop the country’s infrastructure e.g. the transport system which encourages resource movement as well as movement of goods in the different areas in addition to encouraging more production whic h reduces shortages and hence preventing prices from rising. OR Well developed infrastructure/ improved road network or better roads facilities quick delivery of goods to market places. This eliminates scarcity of goods since aggregate supply increase hence reducing inflation.

Undertake trade liberalization. This leads to an increase in the level of investment which increase output of goods and services and thus reducing shortages which prevents prices from rising.

Controls on trade are relaxed by the government which encourages investors to produce more goods and services and this increases aggregate supply because more goods are available on the market which helps to eliminate scarcity and thus controlling inflation.
Privatise public enterprises. This increase the level of efficiency in the operation of the enterprises which increases production and supply of goods and services on the market thus controlling inflation.
Improve political climate/ maintain stability. This promotes investment in the country which increase production and supply of goods and services thus reducing shortages and hence controlling inflation.

By ensuring political stability, investment is promoted because there is no fear for loss of lives and property. More goods are produced and aggregate supply increases hence controlling inflation.

Provide investment incentives to both the local and foreign investorse.g through extensions of tax holidays to the investors. This promotes investment because it reduces the production costs hence leading to increase in production and supply of goods and services thus controlling inflation.
Use of a restrictive monetary policy e.g through the sale of treasury bills by the central Bank to the public. This reduces money supply and aggregate demand for goods and services thereby controlling inflation.
Reduce government borrowing from the Central bank. This reduces the amount of money in circulation thereby reducing aggregate demand hence controlling inflation.
Modernize agriculture. This leads to an increase in agricultural output even in the dry period which reduces shortages hence controlling inflation.

By modernizing agriculture more food items are produced and supplied on the market. As food items become more available, prices stabilize thereby controlling inflation.

Encouraging use of instruments of credit e.g. cheques, bills of exchange etc. this reduces the use of cash in carrying out transactions which reduces the amount of money in circulation thereby reducing aggregate demand and for goods and services.
Reduce indirect taxes. This lowers the prices of goods and services hence controlling inflation.

Questions

1a) Discuss the causes of inflation in Uganda.

b) Suggest measures that should be taken to control inflation in Uganda.

2a) Account for persistent inflation in Uganda.

b) Explain the measures being undertaken to control inflation in Uganda.

3a) To what extent are inflationary tendencies in Uganda as a result of excessive demand.

b) Discuss the measures used/ taken/ have been taken to control inflation in Uganda.

Stagflation.

This is where high rate of inflation co-exist with high rates of unemployment. It is caused by a decline in aggregate supply which leads to a decline in output hence unemployment due to laying off of workers. NB: the demerits of stagflation are the negative effects of inflation.

Reflationary Policy.

This refers to a deliberate government policy to force prices upwards to recover from a depression.

Instruments / Methods of Reflationary Policy

Increase in government expenditure
Increase in wages
Use of an expansionary monetary policy e.g. buying government securities from the public
Tax reduction on incomes/ reducing direct taxes
Encouraging exports.

Question

Distinguish between deflation and reflation.
Mention two instruments of reflation in an economy.

Inflationary spiral

This refers to a situation where a persistent rise in the general price level creates a persistent demand for higher wages which again generates a further increase in the prices of commodities. The increased wages result into an increase in the cost of production and this forces producers to increase prices of the commodities.

The workers again demand for an increase in the wages and the trend goes on and on. Use of trade restrictions to discourage importation of commodities from countries experiencing.

Why is it difficult to control inflation in Developing Countries

Challenges

High rate of rural-urban migration. This increases the cost of living in town hence inflation.
The need to import essential commodities and raw materials which are lacking in the country e.g petroleum products make it difficult to control imported inflation.
Frequent wage increases by the government. This leads to an increases in the level of income hence increases in demand for goods and services.
The need for high revenue from indirect taxes by the government which causes producers to increase prices of commodities.
Lack of appropriate measures to control populationgrowth rates. This leads to excessive demand for goods and services hence hence inflation.
Political instability and insecurity. These demand for increased government expenditure hence increased money supply and aggregate demand.
Occurrence of unforeseen circumstances e.g pests and disease, bad weather etc which leads to shortage of goods and services especially in the agricultural sector.
Limited capital required to establish industries to increase domestic production of goods and services.
Existence of poor infrastructure e.g. in form of poor transport and communication facilities which makes it difficult to transport goods to areas of scarcity.
Low productivity in the agricultural sector. This leads to shortages of food hence increase in food prices.
High level of corruption and embezzlement of public funds meant for productive activities. This leads to shortage of goods hence inflation.
Under developed financial sector. This makes it difficult to use the tool of monetary policy to control money supply hence inflation.

Circumstances under which inflation may be desirable in an economy.