363 AMERICAN RESEARCH THOUGHTS ISSN: 2392 – 876X Volume 1 │ Issue 1 │ November 2014 Available online at: www.researchthoughts.us DECOMPOSITION ANALYSIS OF INFLATION IN PAKISTAN Muhammad Nadeem 1 , Rabia Nazir 2 , Mansoor Mushtaq 3 1 Graduate from Department of Economics, University of the Punjab, Lahore, Pakistan 2 PhD scholar at Pakistan Institute of Development Economics (PIDE) & Lecturer Economics, Islamia University of Bahawalpur, Pakistan 3 Lecturer Economics, FAST National University of computer & Emerging Sciences, Islamabad, Pakistan Abstract: This paper attempts to decompose inflation (measured by changes in the CPI) into sub patterns that identify each component of inflation separately i.e. trend, cyclical, seasonal and random. For this purpose, a simple method is used here i.e. the general mathematical representation of the decomposition approach pt = f (St, Tt, Ct, Rt). First, seasonality and randomness are eliminated by adding as many values of p as the lag length of seasonality, 12 months when seasonality is monthly (when monthly data is used), 3 when it is quarterly (when quarterly data is used) this is done by calculating moving average. The ratio of p to moving average results in random and seasonal component (St, Rt). The seasonal (St) component is captured by using dummy variables from seasonal and a random (St, Rt) Components what remains is the random (Rt) component. Trend (Tt) is captured by using hp filter and cyclical (Ct) component is decomposed by frequency filter. Decomposition is done by using monthly, quarterly and annual data. While using annual data, seasonality is considered to be unitary so the ratio of p to moving average results in random component. Such decomposition has shed more light on the behavior of the CPI and it is helpful for policy makers to set the policies accordingly Key words: Inflation, Decomposition, Trend, Cycle, Season, Random. INTRODUCTION As far as the definition of inflation is concerned different economists have given different definitions like it is a phenomenon where ȃtoo much money chases too few goodsȄ or it is the decrease in purchasing power of money, In general we can define inflation as ȃit is a persistent rise in general price levelȄ.it should be noted that every rise in price level cannot be termed as inflation, so to call a rise in price level inflation,