What is Inflation?

Inflation is when the prices of goods and services keep rising over time, which gradually takes away all your purchasing power. Simply put, when too much money floods the economy, the value of that money tends to drop, which makes things more expensive. Inflation can force consumers to make tough financial choices as the value of their money has dropped.

Synonyms

• Economic Inflation
• Cost Inflation
• Cost of Living Increase

Types of Inflation

There are different types of inflation such as built-in inflation, cost-push inflation, and demand-pull inflation. 

1. Built-In Inflation

Built-in inflation happens when people start expecting the current prices to move up in the future because they’ve already been rising. Imagine you see the cost of goods and services increasing, you might assume it will continue to be like that. However, when you expect prices to keep rising at the same rate, this belief can really contribute to ongoing inflation. Due to this, businesses and consumers adjust their behavior accordingly.

2. Cost-Push Inflation

Cost-push inflation occurs when the prices of goods and services rise because the cost of production increases. This happens when more money and credit are deposited into the markets for commodities or assets, increasing the costs across the board. 

3. Demand-Pull Inflation

Demand-pull inflation occurs when there is more money and credit available, which causes people to spend more. When there is an increase in the demand for goods and services faster than the economy produces for them, this leads to price rises. 

When people feel good about their finances and they have more money to spend, they buy more which pushes the price to go higher. This creates a situation where demand outpaces supply which leads to higher prices. Because there is more competition for the same amount of goods and services.

Causes of Inflation

Having understood the meaning of inflation and the main types, let’s take a quick look at the causes of inflation:

1. Exchange Rate Changes

The U.S. dollar loses buying power when its value declines compared to other currencies. From another perspective, imported goods which make up the bulk of consumer goods purchased in America become more costly to purchase. This will result in inflation which is thought to be of the cost-push type.

2. Increase in Public Spending

In any modern economy, government spending plays an important role in a nation’s overall spending and significantly impacts aggregate demand. Typically, in less developed economies, increased government spending often leads to inflationary pressures on the economy.

3. Deficit Financing of Government Spending

There are times when the government needs to spend more beyond what taxation can finance. So, to cover this extra cost, they turn to deficit financing, like printing more money. But when they do this, it adds to inflationary pressure.

4. Increased Velocity of Circulation

In an economy, the total amount of money in use is equal to the money supplied by the government multiplied by how quickly that money changes hands. When the economy is growing, people spend money faster, which increases the speed at which money circulates.

5. Population Growth

As more people join the crowd, it increases the demand in the market. And when this demand gets too high, that’s when inflation starts creeping in.

6. Hoarding

Hoarders are people or organisations that store away goods and keep them off the market. By doing this, they create an artificial shortage, driving up demand while supply remains limited. This ultimately leads to inflation.

7. Genuine Shortage

Sometimes, there just aren’t enough resources to keep production going smoothly. This lack of supply leads to a situation where demand exceeds what’s available, causing prices to rise and triggering inflation.

8. Exports

When a country’s production isn’t enough to meet both local and international demand, more goods are sent abroad. This leaves fewer products available for local consumers, which can raise prices and cause inflation.

9. Trade Unions

Trade unions are all about looking out for employees. When prices increase, these unions push for higher wages to help workers keep up. But, as wages rise, it can increase production costs, which often leads to a further increase in prices.

10. Tax Reduction

Taxes usually go up over time, but sometimes governments reduce them to win people over. This makes everyone happy because they have more cash to spend. But if the rate of production doesn’t increase, then the extra cash can lead to inflation.

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