causes

The quantity theory of money

states that:
MV=PY
in which M: Money supply, V: velocity of money that is constant (or
virtually constant), P: overall price level, Y: quantity of aggregate
output. Thus,
Nominal GDP
= P Y.
Money supply (M) can be considered a policy variable set by the central bank.
According to the theory, a change in money supply causes equal percentage
change in nominal GDP. Then, if money supply increases faster than an
increase in real GDP, the overall price level will increase to ensure equality
between two sides of the equation.19

When the money supply increases, this will result in more money chasing the
same amount of goods. The excess money supply will then create a new
equilibrium point in the market. The only difference is an increase in the
overall price level.
The United Arab Emirates Money Supply M0 is the most liquid measure of the money supply
including coins and notes in circulation and other assets that are easily convertible into cash.
Money Supply M0 and M1, are also known as narrow money

Money supply increased from 64000mn AED in 2014 to 73000mn AED in 2015. Money supply
shows an increasing trend since last 5 years, from 45000mn AED inn 2010 to 75000mn AED in
2015.
Inflation rates in 2014 was 1.80% as compared to 5% in 2015. Inflation rates shows continues
increase since 2012.

While the real GDP growth rates were increasing at a much slower rate than the money supply,
this will definitely create more demand than supply, which will lead to inflation.

As oil prices have increased over the past years, the UAE has received an
increasing value of oil revenues resulting in an injection of liquidity into the
domestic markets. The inflationary pressure of money supply could not be
compensated by a rapid increase in domestically produced goods and services.
That results in an increase in prices. This was the situation till 2013.
But in 2014 the oil prices fell devastatingly and continued till 2015. This led to
a decrease in the revenues of the country.
This should lower down the inflation rates in the country. This is because the
money supply will go down and the inflation will be corrected.

The basic cause of inflation is excess aggregate demand stimulated by

private consumption and government expenditures. Since the UAE economy
is a developing economy and is not flexible, the real output could not grow
rapidly as aggregate demand.

We can find out the excess aggregate demand if we calculate it based on

current prices and compare it with real GDP based on constant prices.

Inflation is caused by an excess demand in which demand exceeds supply. The

increase in aggregate demand is caused by a rapid increase in oil revenues
which leads to high rate of government expenditures. For instance demand
for housing units increases faster than the increase in supply of housing units
which results in an increase in rents.

The gap between the nominal GDP(ag. expenditure) and the real GDP(ag.
Supply) kept on increasing.

The gap led to a decrease in inflation in 2010 as compared to 2009 but it again
went up in the following years.

Consumer price index (CPI) in the UAE increased 4.32% in May

2015 in comparison to May 2014, primarily driven by cost of housing
& utilities. In terms of relative contribution housing & utilities
contributed the most (3.69% y-o-y). 85% of the inflation originates
from Housing & Utilities. Approximately 75 -80% of UAE inflation
is domestic in origin.

Domestic/Foreign inflation for the UAE could be broken down as

follows:

Domestic inflation components are: Housing & Utilities;

Maintenance; Health-Care (Partially: Labor-Local/Medicine-Foreign);
Transport; Education; Recreation and Culture; Miscellaneous Goods
and Services; Restaurants & Hotels: Partially (70-30); and
Communication (partially)
The global inflation affected the UAE through imports which are called
imported inflation
Foreign(Imported) inflation components are: Food &
Beverages(non-alcohol); Alcohol & Tobacco; Clothing & Footwear;
Furniture; Textiles and Home Appliances; Partially Restaurants &
Hotels (70-30); and Health-Care (partially) Domestic inflation of
UAE is mainly driven by rising rents. With lower oil prices foreign
origin inflation is expected to decline. Three main reasons that may
drive the decline are:
The most recent housing sales/rental data indicate that rents are
declining as well. The decline in rents will be reflected in the CPI
with a lag of possibly 4-5 months.
Monetary aggregate growth is slowing down
Real Effective Exchange Rate