We know what inflation is but what might be some of the causes leading to rising prices of goods and services? Let’s take a look at what some of the causes can be and how it mostly comes back to one single reason.

Cost-Push Inflation
Let’s say you make chairs for a living and those chairs are made from wood. If the price of wood rises you may have to increase the price of your end product, the chair. Simply, the cost of inputs rises and this increase is passed through to the end price.

Demand Pull Inflation
Demand Pull inflation occurs when total demand for goods and services exceeds total supply. Let’s say in your chair factory you have a machine that makes the legs of the chair. This machine produces legs for four chairs per day, although, you now have orders for 6 chairs. One of those six people really wants his chair so he offers more but the other people want their chairs and a bidding war begins. The price of chairs will remain high until a new machine is installed and production increases.

Rapid growth of overseas countries can also increase demand for locally produced products for export, which in turn increases demand for labor and feeds more money into the economy.

Imported Inflation
Everything might be rosy in your part of the world, although, if you rely on imports and the exporting country is putting the price up, you end up with inflation pressures. Note that currencies play a role here in stabilising prices.

Fiscal Inflation
Government spending can cause an increase in demand for goods, services and labor which may add to price pressures in a ‘tight market’ (ie. low availability of workers and resources). This also adds money to the economy via wages paid out which are in turn spent within the economy via workers seeking goods and services, although, in this ‘tight market’ the government would likely only be crowding out another company or institution seeking workers. Policy and tax changes can also have effects on the way markets operate and consumer spending.

Monetary Inflation
Interest rates are low, people borrow like mad and the economy is fueled with credit, demand skyrockets, prices skyrocket. In this blunt example the end result is an oversupply of money to the economy and at the end of the day it all comes back to this. Simply, it is expressed as too much money chasing the same goods.

The Reserve Bank uses it’s control over monetary policy to effect changes that keep inflation within their agreed target band. Simply, the Reserve Bank increases the cost of funds with the aim of reducing demand.

This Post continues at Money Supply, Monetary Policy and Central Banking

Macroeconomics
cpi, inflation, monetary policy