This document discusses inflation, including its definition, causes, effects, and measures to control it. It defines inflation as a sustained increase in prices or fall in the value of money. Inflation can be caused by increases in demand (demand-pull) or costs of production (cost-push). It affects economies through reduced purchasing power, income redistribution, and uncertainty. Measures used to control inflation include monetary policy, fiscal policy, price controls, and supply-side policies. The document also discusses inflation trends and measures taken in Tanzania, such as increasing interest rates and reducing government spending and subsidies.

1. INFLATION
By sadam jamaldin

2. INTRODUCTION
1.1 Introduction to inflation
Inflation is defined as a sustained increase in the price level or a fall in the value of money. Among
the explanation for inflation is the monetarist theory, which posits that inflation is caused by an
increase in the money supply that outpaces the growth of real output. This theory contends that as the
money supply increases, consumers and firms have more money to spend, leading to an increase in
demand that drives up prices (Mishkin, 2016).
Mathematically rate of inflation can express as
Rate of inflation =
𝑃𝑡−𝑃𝑡−1
𝑃𝑡−1
× 100%
Where 𝑃𝑡 and 𝑃𝑡 − 1 are price level at two time periods respectively, price level is the average of
prices

3. 1.2 Cause and theories
1.2.1 According to rate of inflation
In this category there are four types of inflation
 Creeping inflation: This is the type of inflation which occurs when price rises by 2%
to 3% .This type of inflation is not harmful to the economy since it can stimulate
investments.
 Moderate inflation: This type of inflation occurs when price changes by 4% to5%.
This type is also not harmful to the economy.
 Rapid inflation: This happens when price rises at a rate of 6% per annum. This type is
harmful to the economy.
 Hyperinflation: This is a type of inflation which occurs when price rises daily such
that people lose confidence in their currency

4. 1.2.2 According to cause of inflation
1. Demand-pull inflation, This type
of inflation occurs due to an increase
in demand for goods and services
that outstrips the supply. The
increased demand leads to a rise in
prices, causing inflation
2. Cost-push inflation, This type of
inflation occurs due to an increase in
production costs, such as labor, raw
materials, or energy.

5. 1.2.1 Theories of inflation
i) demand pull theory, is
when there is an increase in
aggregate demand , and the
supply remain the same or
decrease, so demand is
responsible to this inflation
graph of demand pull theory

6. Cont.…
i) cost push theory, occurs
when overalls prices
increases ( inflation) due
to increases in the cost of
wages and raw materials
Graph for the cost push theory

7. 1.3 Impact of inflation
Inflation can have a range of effects on an economy and its participants. Here are five
common effects of inflation,
1. Reduced purchasing power: Inflation can reduce the purchasing power of a
currency, meaning that it takes more money to buy the same goods and services.
2. Redistribution of income and wealth: Inflation affects different groups in
society differently. For example, people on fixed incomes or those with savings
may experience a decline in their real purchasing power.
3. Reduced international competitiveness: High inflation N rates can reduce a
country's international competitiveness by making its goods and services more
expensive compared to those of other countries.

8. Cont.….
4. Uncertainty and risk: High inflation rates can also lead to uncertainty and
risk in an economy. Businesses may be hesitant to invest or expand in an
environment where prices are volatile, which can lead to a slowdown in
economic activity
5. Increase in nominal interest rates: Inflation can also lead to an increase in
nominal interest rates in an economy. As prices rise, lenders may demand a higher
return on their loans to account for inflation.

9. Measures of inflation
Inflation can be measured using price index
It is measured as an annual percentage increase
As inflation rises, every shilling you own buy a smaller percentage of a good or
service
 consumer price index, can be expressed as follows
𝑃𝑛
𝑝0
× 100
 GDP Deflator, can expressed as
GDP Deflator =
𝑛𝑜𝑚𝑜𝑛𝑎𝑙 𝐺𝐷𝑃
𝑟𝑒𝑎𝑙 𝐺𝐷𝑃
× 100

10. 1.4 Measures to control inflation
Monetary policy, One of the key tools used to counter inflation is monetary policy, central
banks can use tools like adjusting interest rates or manipulating the money supply to control
inflation
Fiscal policy, governments can lower spending or increase taxes to reduce demand and lower
prices. Likewise, a government may increase spending on infrastructure projects to enhance
productivity and stimulate supply growth.
Wage and price controls, In cases of severe inflation, governments may also implement
wage and price controls to limit the increase of prices
Supply-side policies, Blanchard (2018) notes that supply-side policies can provide another
way to counter inflation. These policies typically focus on promoting the long-term economic
growth, such as reducing barriers to entry in markets
Exchange rate management, In cases where inflation is caused by a weak currency,
governments may opt to manage their exchange rates to control inflation.

11. 1.5 Inflation in Tanzania
Tanzania has experienced high inflation rates over the years, which have had adverse
economic effects on its citizens. According to the World Bank (2021), Tanzania's inflation
rate averaged 5.8%.Between 2000 to 2019, with occasional spikes to double digits.
To counter inflation, various measures can be used. One of the measures is monetary policy.
The Bank of Tanzania (BOT) can use monetary policy tools such as adjusting the policy rate,
reserve requirements, and open market operations to influence the supply of money, credit,
and interest rates in the economy. According to Sahn et al (2015), the BOT has used monetary
policy to curb inflationary pressures in Tanzania, such as increasing the policy rate from 12%
in 2015 to 16% in 2016 when inflation peaked at 19.8%.

12. Cont.…
Fiscal policy is another measure that can be used to counter inflation. The
government can adjust its spending and taxation policies to regulate aggregate
demand and reduce inflationary pressures. For instance, increasing taxes and
reducing government spending can reduce demand for goods and services and
lower inflation. According to the World Bank (2021), Tanzania's government
implemented fiscal policy measures such as reducing subsidies and increasing
taxes, which helped to lower inflation from a high of 19.8% in 2016 to 3.2% in
2020.

13. Cont..
Price controls can also be used in extreme cases of inflation. Price
controls involve setting a maximum price for goods and services to
prevent sellers from raising prices excessively. However, price controls
may lead to shortages and black markets. Therefore, this measure is not
commonly used in Tanzania.

14. Cont..
Generally, Supply-side policies, such as investments in infrastructure, education, and
research and development, can increase the economy's productivity and reduce the cost
of production, leading to lower prices and inflation. For instance, improving
infrastructure can reduce transport costs and increase efficiency, leading to lower prices
of goods and services. According to the African Development Bank (2021), Tanzania
has invested in infrastructure development, particularly in ports, railways, and roads,
which have improved access to markets and reduced production costs, ultimately
contributing to lower inflation.

15. Prepared by
Sadam Jamaldin