What Are the Causes of Inflation?

Inflation has many causes, but they mainly break down into two camps: demand-pull and cost-push. Demand-pull happens when an increase in the demand for goods and services leads producers to raise prices to maximize profits. Cost-push occurs when producers raise prices because their costs have gone up. Over time, inflation can significantly impact your cost of living, and it affects everyone from ordinary people to businesses and the stock market.

  • Inflation Defined

Inflation is simply a rise in the average price of goods and services in the macroeconomy. Which particular goods and services depends on the measure we are examining.

Consumer price inflation is the one usually in the news, and it takes a weighted average of various items purchased by the typical household (the list being determined by survey and then updated periodically).

The average can rise while some prices have actually fallen, and how much it reflects your personal situation is a function of how closely the basket of goods and services in the index matches your buying patterns.

But, the bottom line is that we say that inflation has occurred when the average price of those goods and services has increased.

  • What Drives Inflation

There are various factors that can drive prices or inflation in an economy. Typically, inflation results from an increase in production costs or an increase in demand for products and services.

  • Cost-Push Inflation

Cost-push inflation occurs when prices increase due to increases in production costs, such as raw materials and wages.

The demand for goods is unchanged while the supply of goods declines due to the higher costs of production. As a result, the added costs of production are passed onto consumers in the form of higher prices for the finished goods.

  • Demand-Pull Inflation

Demand-pull inflation can be caused by strong consumer demand for a product or service. When there’s a surge in demand for a wide breadth of goods across an economy, their prices tend to increase.

While this is not often a concern for short-term imbalances of supply and demand, sustained demand can reverberate in the economy and raise costs for other goods; the result is demand-pull inflation.

Causes of Inflation

• Primary Causes

• Increase in Public Spending

• Deficit Financing of Government Spending

• Increased Velocity of Circulation

• Population Growth

• Hoarding

• Genuine Shortage

• Exports

• Trade Union

• Tax Reduction

• The imposition of Indirect Taxes

• Price-rise in the International Markets

What’s going on with inflation?

The cost of goods and services has steadily increased since World War II, when modern data collection was first made available. That’s partially just because the economy has grown.

But economists like to think about price gains by tracking how much they’ve increased or decreased from the prior-year period.

In recessions, the year-over-year inflation rate tends to fall, reflecting dis-inflationary pressures as millions of consumers remain out of work and demand is subdued.

In recovery periods, the inflation rate tends to pick up, reflecting higher demand and wages as individuals find employment again.

  • Current inflation rate

According to the Bureau of Labor Statistics (BLS), inflation increased 0.8% in February 2022. Because this is a lagging indicator, the most recent inflation statistic will always be the previous month. Over the last 12 months, all items index increased 7.9% before seasonal adjustment. 

To calculate inflation we begin with a “market basket” of goods and services. The price level of this “market basket” is what is measured from month-to-month.

This basket is meant to capture a portion of the items and services that urban households typically consume, but it is not meant to be all encompassing.

Using that market basket, the consumer price index is created and the current value of the market basket is determined by adding each of the totals. 

The next step is to compare the cost of the current market basket of items to the same market basket of items in what is called a base period.

Inflation is then calculated from the change in the price level from the market basket of goods in the base period compared to the market basket of goods in the most recent period. 

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