INFLATION

This refers to the persistent increase in the general price level of goods and
services and a fall in the value of money in an economy in a given period of time.

Inflationary rate.

This refers to the percentage increase in the general price level.

MEASUREMENT OF INFLATION
The following are the methods used to calculate inflation.

1. Use of price index.

Under this method, inflation rate is calculated as follows;

Where pt is the price of the current year.

Pt – 1 is the price of the previous year.

2. Use of GDP deflator.

Under this method, inflation rate is calculated as follows;

OR

STATE OF INFLATION.
This is the speed at which the general price level is increasing in an economy and
it’s categorized according to the different types of inflation. It includes;

1. MILD/CREEPING/GRADUAL INFLATION.
This refers to an increase in the general price level of goods and services at
a slow rate usually less than 10% per [Link] state of inflation is
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 desirable and not noticed by the public. Individuals can hardly complain
therefore it is good for an economy because a small rise in prices of goods
and services acts as an incentive to production.

EFFECTS OF MILD INFLATION ( positive effects).

 It leads to increased incentive to work harder.
 It promotes entrepreneurship as many people are encouraged to risk
in business ventures.
 It leads to increased production and more output hence economic
growth in an economy.
 It leads to exploitation of idle resources as profit levels increase.
 Commercialization is encouraged thus reduction in the subsistence
production.
 Due to increased investments by increased prices, more employment
opportunities are created which improves on people’s standards of
living.
 It encourages increased savings due to increased profits.
 It encourages labour mobility in an attempt to get employment
opportunities and higher wages.
 It provides the government revenue from taxes due to increased
investments.
 Innovations and investments are encouraged in an attempt to make
profits.
2. HYPER/GALLOPING/RUNAWAY INFLATION.
This refers to an increase in the general price level of goods and services at a very
fast rate of more than 10% per [Link] increase takes place within hours,
days, weeks and the state of inflation is noticed by the public. It is a bad state of
inflation for the economy since it discourages investors, producers as consumers
are very reluctant to buy goods and services at high prices. Therefore savings,
investments, employment and income levels reduce.

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 EFFECTS OF HYPER INFLATION ( negative effects ).
 It discourages savings. This is true because postponing consumption means
that goods cost more when bought later.
 Discourages investments. This is due to reduced savings and high interest
rates on loans.
 It makes exports expensive and imports cheap, therefore foreign goods
become competitive in the home market hence worsening the balance of
payment position of the country.
 It promotes rural urban migration and its negative effects. People migrate
from rural areas to urban centers for better wages and employment.
 It leads to increased unemployment. This is true since some firms are
unable to meet production costs hence closing down leaving people
unemployed.
 It leads to loss of confidence in the local currency. Money losses value with
in a very short time thereby requiring people to carry large sums to make
minor purchase.
 It leads to reduction in government revenue. This is due to low incomes and
low profit margin from the investors hence loss of government revenue
from taxation.
 Creditors loose. This is because they are paid what they lent out in
monetary units which have less purchasing power than what they lent out.
 It leads to over exploitation of resources i.e. swamps, forests, etc. are over
used leading to environmental degradation.
 Low income earners suffer/it leads to uneven distribution of income. This is
because it erodes the incomes of the poor more than the incomes of the
rich.
 It leads to increased brain drain. People living in a country where there is
hyper inflation migrate to countries where incomes are higher and more
stable and where prices are also stable.
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  It leads to high crime rate. Crimes like corruption, theft, robbery, increase
because of low income and general economic hardships that make people
to use illegal means in order to survive.
 It leads to a decline in economic growth. This is because it discourages
production due to high costs of production.
 It causes misery among the poor. It causes misery and a sense of
hopelessness among many people who cannot afford the basic needs due
to high price.
 It causes unpopularity of the government. People blame the government
for the social economic hardships they are faced with and may seek both
legal and illegal ways of removing the government of the day.
 It causes strain on citizens due to long hours of work. People are forced to
work for long hours under difficult conditions due to need to catch up with
the ever increasing cost of living.
 It generates industrial and social unrest. This is due to constant demand for
high wages by trade unions which causes strikes and destruction of
property of a given company.
QUESTIONS.
1.a. Distinguish between creeping inflation and hyper inflation.
.b. Assess the effects of inflation in an economy.
2.a. Define the term runaway inflation.
.b. Explain the costs of runaway inflation in an economy.

TYPES OF INFLATION/CAUSES AND SOLUTIONS

(THEORIES OF INFLATION).
1. DEMAND – PULL INFLATION.
This refers to the persistent increase in the general price level of goods and
services due to aggregate demand exceeding aggregate supply at full
employment level of income or resources.
It is sometimes described as ‘too much money chasing too few goods’.

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 CAUSES OF DEMAND – PULL INFLATION.
 Increase in the wage levels. This results into increased volume of
money in circulation which increases aggregate demand in relation to
aggregate supply thereby leading to inflation.
 Excessive issuance of currency in the economy by the central bank.
This increases the volume of money in circulation which increases
aggregate demand in the economy without corresponding increase in
output.
 Excessive inflow of income from abroad/ increased capital inflow
through donations, foreign aid, loans, gifts etc. This leads to increase
in the volume of money in circulation, increased income and
aggregate demand without corresponding increase in commodities
leading to demand – pull inflation.
 Reduced direct taxation. This leaves a lot of disposable incomes in
consumer’s hand which leads to an increase in demand for goods and
services not accompanied by corresponding increase in supply of
goods hence a rise in the general price level.
 Excessive government expenditure (subsidizing producers, providing
free education inform of U.P.E and U.S.E, provision of hospitals, etc.)
This increases the volume of money in circulation and consumer’s
income without a corresponding increase in supply leading to a
persistent increase in the price levels.
 Uncontrolled credit creation by commercial banks. This results into
increased volume of money in circulation, increased incomes thus
increased aggregate demand without increased aggregate supply of
goods resulting into demand pull inflation.

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  Excessive exportation of essential goods. This reduces the amount of
goods available at home resulting into aggregate demand exceeding
aggregate supply hence demand – pull inflation.
 Reduced importation of essential goods that are highly demanded in
the local market. This leads to increased aggregate demand not
accompanied by supply hence demand pull inflation.

MEASURES TO REDUCE DMAND PULL INFLATION.

 Reduce government expenditure. The government should reduce
expenditure on provision of goods and services in non-priority sectors so
that people can now pay for goods and services previously enjoyed free of
charge.
 Increase direct taxes on incomes. This will reduce the disposable income of
the consumer and thus reduce aggregate demand to correspond with
aggregate supply hence reducing prices.
 Carry out wage freeze/ restraint. This can be controlled by the government
through imposing a wage freeze so as to maintain workers incomes at their
current levels and control demand pull inflation.
 Encourage importation of essential goods which are highly demanded in
the local market especially from cheaper sources. This will supplement the
goods produced at home hence aggregate demand corresponding with
aggregate supply, thereby controlling demand pull inflation.
 Undertake restrictive monetary policies. This will reduce on the amount of
money in circulation e.g. increase the bank rate.
 Control population growth rates. This will reduce on the aggregate demand
to correspond with aggregate supply hence controlling demand pull
inflation.
 Use of the price policy. The government should control prices especially by
setting a high minimum price. This will reduce on aggregate demand to
correspond with aggregate supply hence controlling demand pull inflation.

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 2. COST – PUSH INFLATION.
This refers to the persistent increase in the general price level of goods and
services due to rising or increasing costs of production.
CAUSES OF COST - PUSH INFLATION.
 Rising wages and salaries paid to [Link] leads to rising costs of
production and in return employees raise prices of final goods and
services.
 Rising costs of raw materials/inputs. An increase in the price of raw
materials leads to rising average costs of production. Producers
therefore continuously increase prices of final products hence
inflation.
 Rising costs of transport. Most low developing countries like Uganda
have poor infrastructure which pushes transport costs. This increases
average costs of production leading to rising prices of goods and
services in the market hence inflation.
 Rising costs of fuel. Most low developing countries like Uganda
largely depend on oil and since petrol is not locally produced, it’s
expensively imported from petroleum producing countries.
The price for petrol continuously rises leading to increased cost of
production hence cost push inflation.
 Increased interest rate on borrowed capital. Due to the objective of
maximizing profits by banks, the rate of interest on loans charged by
banks is very high. This increases the production costs thereby
leading to rising prices of final products.
 Rising costs of improving working conditions. Trade unions pressure
employers for better conditions of work for example better working
conditions, increased health and housing allowances etc. This
increases production costs leading to rising prices of final products.
 Rising costs of advertisement. Firms try to expand their share of the
market through massive advertisements. Resources used by firms
increase sales, production costs. The costs of sales are shifted by

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 producers onwards to consumers inform of increased prices for the
products hence cost push inflation.
 Rising rates of indirect taxes. Increased tax rates lead to increased
average costs of production. Producers shift the burden of taxation
to consumers inform of increased prices hence cost push inflation.
 Rising rates of rent. These force producers to shift the rent rates
inform of increased prices hence cost push inflation.

SOLUTIONS OF COST – PUSH INFLATION.

 Using a restrictive income policy i.e. keeping low wages through
government legislation for example by use of the maximum wage
policy.
 Reduce interest rates of borrowed capital to lower the cost of
production.
 Granting tax holidays and offering subsidies to producers of essential
commodities. This will push down the prices, reduce the cost of
production and hence reduce cost push inflation.
 Purchasing raw materials from cheaper sources. This reduces costs
on raw materials hence reducing prices of the final production.
 Purchasing raw materials from cheaper sources. This reduces costs
on raw materials hence reducing prices of the final products.
 Improving infrastructures like roads to reduce on the transport costs.
 Use of the wage freeze or restraint. This is done so as to maintain
worker’s wages at their current levels inorder to reduce the rising
wage rates in an economy.

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 FORMS OF COST PUSH INFLATION.
I. Wage – price inflation.
This results from workers’ demand for higher wages through trade
unions which increases the cost of production inform of increased
wage bill and eventually increase in price of goods and services.
Wage price inflation therefore is the persistent increase in the
general price level of goods and services due to workers demand for
increased pay or wages without a corresponding increase in output.
II. Wage – wage inflation.
This refers to the persistent increase in the general price level of
goods and services due to inter- sectoral or inter-firm or inter-
industrial comparison of wages whereby rising wages in an industry
or firm will create an increase in wages in similar occupation
throughout the economy as a result of workers and trader union
pressure.
III. Price – wage inflation.( Spiral inflation ).
This refers to the persistent increase in the general price level of
goods and services that leads to a persistent demand for wage
increase in return leading to increased production costs and increase
in prices leading to further demand for wage increments again.
OR,
It is a situation where the increase in the price level in the economy
forces the workers to demand for higher wages leading to increase in
the cost of production and thus firms ( producers) are forced to
increase prices of goods and services which again forces workers to
demand for higher wages.
This situation is also referred to as an inflationary spiral.
IV. Profit – push inflation.
This occurs when producers or entrepreneurs increase the prices of
their goods and services in order to obtain excess or abnormal
profits. The producers’ high profit motive leads to increase in prices
of goods and services hence resulting into cost push inflation.

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 3. STRUCTURAL /BOTTLENECK/SCARCITY INFLATION.
This refers to the persistent increase in the general price level of goods and
services due to supply rigidities and structural bottlenecks in the sectors of
the economy leading to a decline in the supply of essential goods.
CAUSES OF STRUCTURAL INFLATION.
 Breakdown of infrastructure such as roads, bridges causing difficult in
transporting commodities from areas of plenty to areas of scarcity hence
increasing prices in areas of scarcity.
 Natural calamities or hazards like floods, drought, outbreak of diseases etc.
This causes drastic reduction in supply of agricultural commodities hence
an increase in the prices.
 Political instabilities. These discourage productive activities causing
shortages of goods and services leading to increase in prices.
 Scarcity or exhaustion of raw materials or inputs leading to shortages of
goods hence increasing prices.
 Breakdown of major industries hence causing shortages of goods in the
economy leading to increase in prices.
 Hoarding of goods by some business men who end up causing artificial
shortages of goods hence increasing prices of commodities.
 Shortages of foreign exchange. This is sometimes caused by a decline in
export earnings which leads to low supply of goods and services hence
increasing prices.

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 SOLUTIONS TO SRTUCTURAL INFLATION.
 Encourage diversification of the economy so as to create a variety of
productive activities. These will increase supply in order to correspond with
demand leading to a reduction in prices.
 Improve the infrastructure like roads and bridges to ease the mobility of
goods and services to areas of scarcity hence a reduction in prices.
 Improve political climate so as to attract more potential investors. This will
increase on output to correspond with the demand hence a reduction in
prices.
 Carry out agricultural modernization to reduce on the dependence on
nature e.g. undertake irrigation to overcome the problems of natural
calamities like drought and ensure constant supply of raw materials to aid
production.
 Encourage private, local and foreign investors or carry out further trade
liberalization. This will lead to an increase in production to correspond with
increased aggregate demand hence a reduction in prices.
 Import raw materials or inputs from other countries hence ensuring
continued production thereby overcoming problems of scarcity of goods.
 Rehabilitate and establish more industries in order to increase output and
overcome problems of scarcity hence reduction in prices.
4. IMPORTED INFLATION.
This refers to the persistent increase in the general price level of goods and
services due to importation of goods and services from countries already
experiencing inflation leading to price increment in the domestic economy.

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 CAUSES OF IMPORTED INFLATION
 Importation of goods from countries already experiencing hyper inflation.
 Rising oil prices. This leads to a rise in prices of related goods.
 Importation of intermediate goods or inputs at higher prices.
 High transport costs for imports e.g. high flight rates or shipping costs.
 High import duties or tariffs imposed by the government.
 Devaluation measures taken to make exports cheap and imports expensive
causing inflation. This is due to importation of highly priced products
especially when imports are price inelastic in demand.
SOLUTIONS TOIMPORTED INFLATION.
 Encourage importation from cheaper and friendly sources.
 Promote import substitution policy. The government should promote the
establishment of industries to produce goods locally which were previously
imported into the country.
 Subsidize importers through reducing import duties. The government
should provide subsidies to the importers so to stabilize and lower the
prices of imported goods.
 Import restriction. The government should impose restrictions on the
importation of goods from countries experiencing inflation so as to
minimize the chances of high priced goods.
 Carry out import trade agreements. The importing government should sign
an agreement to the exporting countries to ensure that imports are sent at
a constant price.
 Price negotiations. The government should send delegates to other
countries to negotiate for lower prices hindering importation of highly
priced commodities.
5. MONETARIST INFLATION.
This refers to the persistent increase in the general price level of goods and
services due to excessive money supply in the economy without
corresponding increase in the volume of output.

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 6. SPECULATIVE INFLATION.
It refers to the persistent increase in the general price level of goods and
services due to anticipation of future increase in prices that eventually
lead to increase in demand forcing the producers to increase prices of
goods and services.

THE GENERAL CAUSES OF INFLATION.

1. Break down of infrastructure such as roads, bridges and railways. These
are ever breaking down making it very expensive and difficult to
transport raw materials to production centers and finished goods to
market centers. This results into reduced levels of production causing
shortages of commodities in the economy leading to inflation.
2. Natural hazards or calamities such as drought, landslides, pests and
diseases etc. These lead to drastic fall in supply from the agricultural
sector yet demand for such commodities is increasing pushing prices
upwards.
3. Political instability/unfavorable political climate in some parts of the
country. This leads to destruction of productive infrastructure leading to
a fall in the levels of output in the economy in relation to demand hence
causing inflation.
4. Break down of industries. The breakdown of key industries that produce
consumer goods result into reduced supply of consumer’s essential
goods yet demand is increasing, hence inflation.
5. Greed for profits by traders. Some traders want to obtain a lot of profits
therefore cause artificial shortages of goods by hoarding them so as to
increase prices yet demand is increasing .This causes inflation in the
economy.
6. Excessive exportation of essential goods like sugar and other food stuffs
to neighboring countries like Kenya, Rwanda. This leads to shortages of
goods in the domestic economy yet their demand is increasing hence
leading to inflation.

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 7. Decline in the value of the local currency relative to other currencies.
The value of the local currency has been persistently falling in relation to
foreign currencies especially in Uganda. This has made it very expensive
to import raw materials and other essential commodities leading to
price increase in the domestic economy due to shortages of these
commodities.
8. Excessive issuance of currency by the central bank. The central bank is
excessively issuing a lot of currency in the economy without
corresponding increase in the level of output being produced. This is
excessively increasing aggregate demand over aggregate supply causing
demand pull inflation.
9. Excessive/uncontrolled credit creation by the commercial banks.
Commercial banks in the country are lending money to willing
borrowers excessively so as to earn more profits by charging interest on
them. This is putting too much money in circulation causing excessive
aggregate demand over aggregate supply leading to inflation.
[Link] inflow of funds from [Link] like Uganda receive a lot of
income from abroad inform of donations, grants, income of nationals
from abroad. This results into excessive money supply in the economy
causing excessive aggregate demand over aggregate supply leading to
demand pull inflation.
[Link] government expenditure. Government spends excessively on
issues like elections, infrastructure, wages, compensations etc. thereby
leading to excessive money supply in the economy that leads to
excessive aggregate demand over aggregate supply causing inflation.
[Link] direct taxes/Reduced income taxes. This leaves a lot of
disposable income in consumers’ hands which results into increase in
aggregate demand for goods and services often not accompanied by a
corresponding increase in supply hence inflation.
[Link] costs of production.e.g. rising wages, costs of raw materials, rising
prices of fuel, increasing interest rates on borrowed capital,rising costs
of advertisement [Link] costs force the producers to increase the
prices of final goods and services in order to cover such costs and at the
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 same time maintain their profit margins hence leading to cost push
inflation.
[Link] of goods from countries already experiencing
[Link] like Uganda over rely on imports but some of these
imports are bought from countries that are prone to inflation and
therefore sold in the domestic market at high prices thereby imported
inflation.
[Link] by traders and consumers. As consumers anticipate future
price increase they increase their demand for the available goods on the
market whose price is expected to increase. Such increase in demand
forces producers to increase prices of goods and services hence causing
inflation.

N: B;
Emphasis on explanations should address issues/ factors that
lead to scarcity of goods relative to their demand forcing
prices upwards.
OR,

Factors that put too much money in circulation leading to

excessive aggregate demand without corresponding increase in
output pushing prices upwards.

REVISION QUESTIONS.

 Account for the existence of inflation in Uganda.

 Account for the persistent increase in the general price level in Uganda.
 Explain the causes of galloping/hyper/run-away inflation.

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  To what extent is inflation in [Link] caused by rising costs of production?
To a smaller extent, Inflation in [Link] is caused by rising costs of
production such as;
 Rising costs of raw materials.
 Rising wages and salaries.
 Rising costs of fuel/energy.
 Rising rates of rent.
 Rising costs of borrowing.
 Rising rates of indirect taxes.
 Rising transport costs.
 Rising costs of improving working conditions due to trade union pressure.
However, to a larger extent, inflation in [Link] is caused by other factors
other than rising costs of production as explained below;
 Break down of infrastructures.
 Excessive/uncontrolled credit creation by commercial banks.
 Excessive inflow of funds from abroad.
 Excessive government expenditure.
 Excessive exportation of essential goods.
 Decline in the value of the local currency relative to other currencies.
 Importation of goods from countries experiencing inflation.
 Greed for profits by traders.
 Speculation by traders and consumers.
 Natural hazards/calamities such as drought, landslides.
 Political instability/unfair political climate in some parts of the country.

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 MEASURES THAT SHOULD BE TAKEN TO CONTROL
INFLATION IN [Link].
The measures that should be taken to reduce inflation in [Link] like Uganda are;

1. Reduce government expenditure especially on provision of non-essential

goods. This will help to reduce the amount of money in circulation and
aggregate demand in the economy which will lead to a fall in prices of
goods and services.
2. Further liberalize the economy. Liberalization of the economy involves
removing unnecessary restrictions on economic activities. This will give
people liberty to carryout economic activities without unnecessary
government interference. This will increase the level of output in the
economy and competition among producers and traders leading to a fall in
prices of goods and services.
3. Improve the investment climate. This is achieved through providing tax
holidays, free land for investment, subsidies to reduce production costs and
attract more investors which will help to increase output in the economy
hence leading to a decline in the prices of goods and services.
4. Develop infrastructure such as roads, bridges, railways. These
infrastructures will facilitate fast and cheap movement of raw materials to
production centers and finished products to markets thereby leading to
increased production/supply of goods and services.
5. Modernize the agricultural sector. This can be done through transforming
the subsistence sector to the commercial sector characterized with high
yielding production through use of methods such as irrigation, land
reforms, use of demonstration farms etc. This will help to increase the
supply of agricultural commodities hence leading to a fall in prices.
6. Control issuance of currency by the central bank. The central bank should
control issuance of currency especially that which is not in line with the
level of economic activities in the country. This will reduce excessive money
supply in the economy which will reduce aggregate demand thereby
controlling demand pull inflation.

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 7. Carryout further privatization of state owned enterprises i.e. transfer
ownership of state owned enterprises to private individuals. This will
increase efficiency in the running of the enterprises and the scale of
production will expand. This will increase production of goods and services
in those enterprises hence controlling structural inflation.
8. Improve the political climate/atmosphere. This can be achieved through
negotiating for peace talks with the rebels and other discounted
group/disgruntled/opposition group in the country. This will promote
production of more goods and services and also attract more investors thus
increasing the productive capacity of the country leading to a fall in price of
goods and services.
9. Reduce indirect taxes especially on essential goods such as petroleum
products, soap, sugar etc. This will reduce on production costs, increase
output which eventually will lead to a decline in prices.
[Link] export of some goods produced in the country e.g. sugar, meat,
and other food stuffs. This will ensure adequate supply of such goods in the
local market hence overcoming the problem of scarcity .This will lead to a
decline in prices.
[Link] import substitution industrial strategy were by goods that were
formerly imported are produced internally thus enabling the country to
overcome imported inflation which arises due to importation of goods from
countries experiencing inflation.
[Link] direct taxes especially on high income earners so as to reduce
their disposable income which reduces their purchasing power hence
controlling the level of aggregate demand in the economy leading to a fall
in prices of goods and services.
[Link] the use of instruments of credits such as use of cheques, bank
drafts, promissory notes, etc. This will help people to move with such
written documents instead of moving with big sums of money that
encourage them to spend thereby controlling aggregate demand leading to
a fall in in prices.

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 [Link] of price control especially maximum price legislation i.e. This policy
involves fixing prices below equilibrium price such that even when there is
excess demand, prices cannot be increased leading to a fall in prices.
[Link] a restrictive monetary policy e.g. Through increase of
government bank rate and sale of government securities (Treasury Bills and
Bonds). Such polices reduce the capacity of commercial banks to create
credit thereby reducing the money in circulation hence controlling
aggregate demand leading to decline in prices for goods and services.
16. Wage control measures / controlled trade union influence.
[Link] saving schemes e.g. NSSF should be ensured.
QUESTIONS.
1. Explain the measures that are being taken to control
inflation in Uganda. (Is/are being/ing).
2. What measures have been taken to control inflation in
Uganda? (Has/have been).
3. Suggest measures that should/can/may be taken to
control inflation in [Link] like Uganda.( should/can/will).

EFFECTS OF INFLATION IN AN ECONOMY.

POSITIVE EFFECTS.
1. Mild inflation helps the economy to recover from a recession/
depression. This is because the increasing prices being experienced in
the economy promote more investments and lead to increase in supply
of goods due to increased profits there by pulling the economy out of
recession.
2. It stimulates peoples’ effort. This is because they have to work harder to
meet the increasing cost of living as prices of goods and service increase
thereby helping the economy to increase its production capacity.
3. Increased prices stimulate investments. This is because they increase
the profits of the producers and such investments lead to increased
production (output) leading to high economic growthrate.

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 4. Employment opportunities are generated. This is due to the fact that as
prices increase entrepreneurs are encouraged to work harder and
increase their scale of production which necessities employment of
more workers.
5. Government revenue increases. This is mainly through increasing direct
taxes on incomes of the rich so as to reduce on their purchasing power.
The revenue collected through taxation is used to meet government
needs.
6. It encourages forced savings. This is because the funds which would
have been spent are saved to be spent later on when inflation rates are
low because as prices increase, the purchasing power of money reduces.
7. It encourages innovativeness and creativity in the economy. This arises
due to the need for producers to obtain higher profits and survive the
harder times when inflation rates are high. Producers increase research
and improve their production techniques so as to continue surviving in
the business leading to improved quality and quantity of output
produced in the economy.
8. Borrowers / debtors stand to gain. This is because they borrow money
when its purchasing power is high due to low prices of goods but pay
back/return the money when inflationary rates are high implying that by
the time they pay back this money, its purchasing power is low.
9. It encourages labor mobility both occupationally and geographically and
its associated benefits. This is because, as the cost of living increases due
to increased commodity prices, some workers tend to look for better
jobs which are relatively paid better.
[Link] encourages the adoption of import substitution industrial
development strategy. This is in the case of imported inflation whereby
industries are set up to produce goods locally which were previously
imported as a way of reducing importation of highly industrial goods
hence leading to increased development in economy.

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 NEGATIVE EFFECTS
1. It discourages local and foreign investors due to persistent increase in the
production costs. Also increased prices of goods and services leads to
reduced demand for goods and services causing producers to make losses.
2. It leads to loss of confidence in the country’s currency. This is because as
prices persistently increase, the value for money falls continuously making
people not to trust the country’s currency as a medium of exchange.
3. It worsens the balance of Payment (BOP) position of the country. This is
because foreign products are imported in large quantities when demand
pull inflation occurs leading to BOP problems.
4. It leads to industrial unrest especially strikes. This is because workers
continuously demand for higher wages to meet the rising cost of living and
this disrupts the production process leading to less output being produced
by the industries.
5. It makes planning difficult. Planning on the side of producers,
government and consumers becomes very difficult since prices are not
stable therefore being unable to know how much to save and how much to
spend.
6. It leads to brain drain. Inflation makes the economy and the country’s
highly skilled man power to move to other countries where there is
economic stability and better payment opportunities leaving the country
with limited supply of skilled manpower hence retarding economic growth
and development.
7. People are over strained. This is because they have to work extremely hard
fore-go leisure and work under poor working conditions in an attempt to
cope with rising cost of living.
8. Government becomes unpopular. This is because the population blames
the government for their suffering due to its failure to curb the inflation
resulting into demonstrations, riots and sometimes political instabilities.
9. Lending is discouraged as creditors stand to lose. This is because whenever
prices increase the value of money decreases therefore lenders receive

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 back their money with a low purchasing power than when they lent out
before the prices increased.
[Link] to production and consumption of low quality goods. This is because
production becomes less affordable due to high production costs involved.
[Link] encourages illegal activates such as corruption, smuggling, prostitution
etc. This makes the government to lose a lot of revenue which would
otherwise be realized through taxation.
12. Discourages saving. This is because the funds which would have been
saved are used to purchase goods and services at higher prices thereby
limiting the level of capital accumulation in the country.
[Link] leads to collapse of some firms. High cost of production incurred by firms
during periods of high inflation rates such as high cost of raw materials,
fuel, rent force some firms to close down leading to reduced output and
retarded economic growth.
[Link] to unemployment. This is because firms are forced to close down as
production costs increase and others substitute labor with machines to
increase on resource exploitation and also cut down the cost of supporting
the existing labor.
[Link] income earners suffer. This is because, as prices increases, the
purchasing power of these people reduces since their income remains the
same yet the cost of living is rising. This lowers their standard of living.

QUESTIONS.

1. Explain the adverse effects of inflation in Uganda

2. What steps have been taken to control inflation in Uganda?
3. Justify the rational of controlling inflation in Uganda.
4. Why is it necessary to control inflation in Uganda?
5. Why may the government control inflation in Uganda.
6. Account for the need to control inflation in Uganda.

NB. A student must be well vast with the negative effects of

inflation if they are to attempt such a question.

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Answers should address the intention/ objectives.

SOLUTIONS

The need to control inflation in Uganda is due to the following reasons.

1. To attract local and foreign investors.

2. To reduce capital outflow
3. To avoid loss of confidence in the country’s currency.
4. To reduce un even distribution of income.
5. To reduce brain drain.
6. To reduce industrial unrest arising due to increased demand for higher
wages.
7. To make government more popular.
8. To avoid straining the people which arise as the cost of living increases.
9. To discourage production and consumption of poor quality goods.
[Link] overcome illegal activities.
[Link] encourage savings
[Link] encourage resource exploitation/ to accelerate economic growth.

OTHER CONCEPTS UNDER INFLATION.

1. DEFLATION. This refers to a persistent decrease in the general price level of
goods and services mainly due to a fall in aggregate demand.

CAUSES OF DEFLATION.
1. Increased direct taxes on peoples incomes
2. Reduced incomes. Wages
3. Reduced inflow of incomes from abroad
4. Reduced government expenditure especially on provision of essential
goods.
5. Use of restrictive monetary policy e.g. Increased bank rate/ interest rate.
This reduces on the amount of money in circulation which leads to a fall in
aggregate demand hence a fall in prices.

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 6. Reduced exportation of goods causing excessive supply of goods in the local
market hence a fall in prices.

EFFECTS
1. Leads to high unemployment levels. As prices fall, profits fall which makes
firms to close down due to failure to cover the production costs hence
unemployment.
2. Leads to a decline I government revenue incomes because some firms
reduce operations.
3. Discourages investment since low prices scare both local and foreign
investors.
4. Leads to slow economic growth rate since low prices lead to declining
operations.
5. Leads to low resource exploitation due to decline in profit margins as prices
fall.
6. It makes people more confident in the currency because as prices reduce,
the value of money increases.
7. Creditors gain as debtors lose because creditors receive back their money
when it has more purchasing power than when it was lent out.

2. STAGFLATION.
This is a situation in which high inflation rates co-exist with high levels of
unemployment.

Effects
1. Leads to brain drain
2. Results into low government revenue.
3. Results into low production due to high cost of production.
4. Increases income and wealth inequalities.
5. It leads to low aggregate demand due for goods and services.
6. Leads to decline in savings.
7. Makes the government unpopular.

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 MEASURES TO REDUCE STAGFLATION.
1. Reduce direct taxes to increase disposable income which increases
consumption hence encouraging investment.
2. Subside production to reduce cost of production.
3. Increase government expenditure especially on productive ventures hence
increases the level of production which increases employment
opportunities.
4. Increase on the amount of money I circulation through the use of an
expansionary monetary policy eg. Reducing the bank rate which leads
provision of effective loans for innovation.
3. STAGNATION
This refers to an economic period of static economic activities characterized
by low levels of investment, employment and constant economic growth
rates.
CAUSES

 Reduced government expenditure

 High indirect taxes
 Low income levels
 Unfavorable political climate
MEASURES TO CURB STAGNATION.

1. Improve the political climate. This helps to promote economic activities and
attract more investors thereby leading to increase in incomes, output,
investment and employment opportunities.
2. Give incentives to investors e.g. Tax holidays, subsidies etc. this increases
innovations, create more employment opportunities and more output
increases helping the economy overcome stagnation.
3. Reduce direct taxes. This increases disposable incomes of consumers which
stimulate investment, employment and output.
4. Increase government expenditure especially on provision of essential
goods.

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 5. Use of an expansionary monetary policy e.g. reducing the bank rate.
6. Develop infrastructure.
4. REFLATION. (Reflationary Policy)
This refers to the deliberate government policy of forcing prices upwards so as to
recover from a recession.
Instruments of a reflationary policy.
 Tax reduction.
 Expansionary monetary policy.
 Increase on government expenditure/ subsidization.
 Increasing wages.
 Encouraging exports.
5. OPEN INFLATION
This is where the persistent increase in the general price level is as a result of
operation of a free market system whereby resource allocation is done by the
market forces of demand and supply with limited or no government intervention.
6 SUPPRESED INFLATION.
This is a situation where demand exceeds supply and the effects of this on
prices are minimized by price control and rationing.
7 HEADLINE INFLATION
This is where the persistent increase in the general price level in the economy
includes the prices of food stuffs.
8 UNDERLYING INFLATION
This is where the persistent increase in the general price level in the economy
includes all commodities in the country but excludes price of food stuffs.
Question
Why may an increase in money supply not necessarily lead to inflation in
Uganda? (Refer to Money and Banking).

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RELATIONSHIP BETWEEN INFLATION AND INTEREST RATE.
1. High level of unemployment lead to a decrease in output hence aggregate
demand exceeding aggregate supply leading to inflation.
2. High levels of inflation prompt producers to lay off worker to cut
production costs leading to unemployment.
3. In order to control unemployment, measures to increase investment are
undertaken. The measure lead to an increase in money in circulation hence
increased aggregate demand and inflation.
4. Both high levels of inflation and unemployment leads to increased crime
rates, reduced government revenue, Rural Urban Migration, and
unpopularity of government.

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