Inflation likely to persist even after drop in fuel prices

June 06, 2023

Uzair bin Farid

The decision of the government to reduce fuel prices will provide breathing space to the masses, but the overall level of inflation is expected to persist. According to WealthPK research, the behaviour of prices is ‘downward sticky’. It means that when prices in the market rise, they tend to stick to their new levels. Prices of other commodities do not decrease even if prices of essential inputs like fuels are decreased at the directions of a controlling authority.

The decision of the federal government to decrease the prices of fuel is a welcome step given that it is one of the major costs for the working people. However, there is a misplaced expectation that if the prices of fuel come down, the prices of all other goods in the market will also decline. Economic research and the behaviour of prices is enough evidence to show that prices in the market continue to increase over the long-term horizon. This can be witnessed from the incomes of people who have worked in a particular economy over their lifetimes.

Incomes tend to increase from very low to very high over the span of a whole life. People who spend their whole lives in a single profession or career know this. The increase in incomes, however, is balanced by the concomitant increase in the prices of goods and services in the market. This results in a loss of purchasing power if the incomes are not rising at the same rate as the prices.

Thus, the behaviour of prices over the longer term has always been ‘downward sticky’ or ‘downward rigid,’ meaning they do not decrease. The current economic situation in Pakistan represents an impasse for the people and the government. The government has to face the demand of people that prices be controlled whereas the behaviour of prices is that they are best determined in the market.

The government can reduce the prices of goods like fuel, but a more comprehensive intervention in the market to control all the prices will be a deviation from the free market principles. Historical research also shows that controlling the market and the prices in it introduces an inefficient system of resource allocation. In that case, those producers who produce the best item and who deserve to be paid higher are not rewarded according to the worth of their produce.

Introducing this kind of equivalence in the rewards to people who produce the same goods, but of starkly different qualities, is a mismanagement of the highest sort. The best is not rewarded whereas the worst is supported to stay in the market. In the end, the whole incentive structure is distorted with the best producers slowly being crowded out. It is highly important for the government to manage the prices of goods and services in the country while remaining very meticulous so as not to distort and destroy the incentive structures that are in place in the economy.

Credit: Independent News Pakistan-WealthPk