The Effects of Inflation on Budgeting and Budgetary Control:


An Investigation into the Effects of Inflation on Budgeting and Budgetary


Control in the Public Sector


           


            Inflation is generally defined as the sustained increase in the prices of goods and services. This economic phenomenon is an important concern as it impacts on the economic well-being of the population and the general economy. Inflation significantly lowers the purchasing power of money since only a few goods or services can be bought vis a vis a previous index of inflation, usually the Consumer Price Index. Inflation is unpredictable and can severely disrupt the economy. To control the level of inflation governments equip themselves with economic tools such as monetary policy, fiscal policy, price control, tariffs and monopolies. The primary and the commonly used tool is monetary policy because it has been proven over time as an effective tool against inflation. The monetary policy is carried out by the government controlled central bank. During periods of inflation, the central bank lowers interest rates in order to increase monetary supply and stimulate the economy. Price inflation also impacts on the ‘time vale of money’. Inflation rate increases will also cause a change in the rate of interests. For example, lenders increase interest rates during inflationary period to make up for the loss of the value of their money during the term of the loan. . (Price Inflation, 2004)


            Inflation, since it is unpredictable and since it negatively impacts any financial entity big or small, is considered in the computation of a budget. Inflation is adjusted to reflect a realistic projection of inflationary rates over a period of time. Thus inflation and budgeting is inseparable (Economy Watch, n.d.) A budget is a plan that is expressed in monetary form. It shows computed projections on income, expenditure and capital. This monetary plan is approved before the budget period. Budgetary control on the other hand, is the comprehensive system of budgeting to aid management in carrying out its functions. (Slideshare, 2011). Budgetary control is important for planning, coordination and control. However, budgetary control includes budgets that are merely monetary estimates, it promotes efficiency in the management of the organization’s financial health. (Surajkumar, 2011). It is said, that. “budget is just the means, while budgetary control is the end (Anonymous, 2010).


            Inflation impacts the government in many ways. Inflation increases revenues because the government has higher tax revenues. Inflation slows down the economy because with the exorbitant price increase people tend to buy less. Inflation will also devalue exchange rate versus foreign currency. It also makes products of imported goods cheaper while domestic products higher. Finally, with inflation, savings decrease because people are spending more for less number of goods and services leaving nothing for savings and thus hurting fixed rate investments. (Csanad, 2011)


            Recognizing the effects of inflation, first world countries use the Model of Inflation Targeting to manage their economy. Inflation Targeting has five elements: 1. Public announcement for target of inflation; 2. Institutional commitment to price stability; 3. Information inclusive strategy; 4. Increased transparency, and; 5. Increased accountability. Inflation targeting is first adopted by New Zealand in 1999. Later a number of industrialized countries adopted the new model such as Canada, the United Kingdom, Sweden, Israel, Australia and Switzerland. (Mishkin, 2001). The model is increasingly popular because it combines two important aspects for a successful monetary policy. These are a “credible medium-term anchor for inflation” and flexibility in terms of its response to inflationary shocks. (Pétursson, 2004) The adoption of the Inflation Targeting Model helps central banks to bring inflation rates down. (Mishkin, 2001).


            Generally the effects of inflation on public sector budgeting and budgetary control on any first world countries are the same such as: increase in government revenue, slowing down of the overall economic activity, devaluation of the exchange rate vis a vis a foreign currency, reduction in the revenues from domestic products because imported products are cheaper and decrease in the over-all savings. (Csanad, 2011).


            Since revenues, income and capital are important elements in budgeting. And since, these are the very things that are affected during inflation. These are also the elements that should be adjusted for projected inflation. The effects of inflation on budget and budgetary control on any sector public or private on developed and developing countries are significantly painful and should not be taken for granted. The Inflation Targeting Model discussed is a helpful tool in cushioning the impacts inflation in the medium term. 


REFERENCES


Csanad, 2011. Effects of Inflation, the Positives and the Negatives. [online] Available at: <http://hubpages.com/hub/Effects-of-inflation> [Accessed 3 May 2011].


Economy Watch, n.d. Inflation and Capital Budgeting. [online] Available at: <http://www.economywatch.com/budget/types/inflation-capital.html>  [Accessed 3 May 2011].


Mishkin, FS., 2001. Inflation Targeting. [online] Available at: <http://www0.gsb.columbia.edu/faculty/fmishkin/PDFpapers/01ENCYC.pdf> [accessed 3 May 2011].


Pétursson, TG., 2004. The effects of inflation targeting on macroeconomic performance.  Central Bank of Iceland. Economics Department. Working Paper No.23. [online] Available at: <http://www.seðlabanki.is/uploads/files/WP-23.pdf> [Accessed 3 May 2011].


 


Slideshare, 2011. Budget and Budgetary Control. Slideshow.[online] Available at: <http://www.slideshare.net/ashishnangla/budget-and-budgetary-control-presentation> [Accessed 3 May 2011].


 


Surajkumar, P., 2011. A Study of “Budgetary Control System as a Tool of Finance Control”: Need and Importance. [online] Available at: <http://www.scribd.com/doc/13044904/Need-and-importance-of-budgetary-control-system> [Accessed 3 May 2011] .


 


____, 2010. Objectives of Budgetary Control. [online] Available at: <http://www.quickfinancecheck.org/objectives-of-budgetary-control> [Accessed 3 May 2011]


 


____, 2004. Price Inflation. [online] Available at: http://www.getobjects.com/Components/Finance/TVM/inflation.html>  [Accessed 3 May 2011].


 



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