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Principal Causes of Inflation

You may have heard that November 2021 inflation hit that highest rate in 30 years, but what does it mean and how does it affect you? Let's start with the basics.

Inflation is an economic phenomenon in which the value of goods and services in an economy increases over time. Have you ever heard anyone talk about how you could get a coke for a nickel in the '60s? The reason a soda is now $2 is inflation – the relative value of money has gone down compared to the price of goods.

In general, there are two main types of inflation that interest economists. In this post, we explain these two causes, explain factors that influence inflation, examine how experts suggest how we can counteract inflation, and what you can do about it. But first, we'll look at the current causes of inflation and how they affect your current spending power.

4 main causes of inflation in our current economy

In the past few months, you may have noticed that the prices of everything from groceries to gasoline have risen, with consumer prices soaring 6.8% compared to this time last year. That is the power of inflation. But what is currently causing inflation and this unwanted strain on your wallet?

In relation to the current economy, there are a few reasons for inflation:

1. Increase in the money supply:

An increase in the money supply is said to help boost the economy by helping put more money into the hands of consumers. While this might sound like a positive shift, it can actually have negative impacts on the economy, such as: B. a contribution to inflation.

The Federal Reserve has printed trillions of dollars over the past two years, which has contributed to the devaluation of the US currency and the high rate of inflation we are currently witnessing – and speculation is that this will continue.

Not only that, the money supply has been growing faster than the rate of production, contributing to shortages. And the more money there is, the more money consumers can spend – which in turn boosts consumer demand.

However, as demand exceeds production, there are many shortages across the country.

2. Supply chain disruption:

Whether you're at the grocery store or waiting for something to ship from overseas, you've probably had trouble getting hold of certain goods over the past few months. There are a few factors that play into this current problem.

First, during the peak of the pandemic, many companies scaled back production because consumers were not spending. However, now they are and companies have been trying to catch up.

Combine this with the shortages in a general lack of supplies to produce specific goods and it becomes a compounding problem.

And we haven't even experienced the traffic jams at the various ports across the country that have resulted in a huge amount of goods being stuck for long periods of time, sometimes months. With goods stuck in these ports and unable to be unloaded, this means many shelves will remain empty.

3. State-sponsored unemployment:

In response to the surge in job losses in 2020, there have been increases and expansions to existing unemployment programs at both the state and federal levels. While this has helped many people get back on their feet as many people are unwilling to go back to work for previous wages – coupled with health and safety concerns – we are now seeing long-term implications, reflected in current inflation affect.

At the heart of the problem is that government-sponsored unemployment benefits pay workers not to work, leading to labor shortages. Ultimately, this means that companies have to increase wages in excess of unemployment benefits.

As a result, companies need to transform and restructure their approach to compensation and employment. While some businesses will be able to adapt to demands for higher wages to ensure they have the staff they need to support their operations, many small businesses will not.

4. Bad government policy:

Bad government policies can affect inflation – fossil fuels being the most specific to our current circumstances. If you have a car, you've probably seen the rise in gas prices over the last year.

While these guidelines need to be addressed, this is not a quick fix. US oil production and refining was down this year for a number of reasons, including Hurricane Ida, which impacted oil supplies. In addition, the oil-exporting countries are not supplying enough, and there are supply constraints on both sides of the equation.

Given the supply bottlenecks and the currently rising demand for petrol, prices are unlikely to fall again in the near future.

Now that we have a better idea of ​​what factors have recently contributed to inflation, let's look at the causes of inflation from a more general perspective.

What are the general causes of inflation?

It's important to take the time to delve deeper into inflation as a whole so you better understand how and why inflation occurs and how it affects the economic impact on consumers.

There are two major, general causes of inflation. Each is also its own type of inflation and requires its own unique response from policymakers. The two main causes of inflation are:

Demand-pull inflation: Demand-pull inflation occurs in a strong economy. Incomes are rising, people are being paid better, more people are working, and they are demanding more goods and services. This reduces the total number of goods and services available – more people can afford the limited range of goods and services available. This in turn increases prices. In general, some demand-pull inflation is a sign of a functioning economy, as people are working and making enough money to demand whatever is produced.
Cost Pressure Inflation: Cost-push inflation is caused by an increase in the cost of goods due to supply-side causes. For example, if the cost of raw materials increases significantly and companies cannot sustain the production of finished goods, this will cause the finished goods sold in the market to become more expensive. Natural disasters, pandemics, and rising oil prices, for example, can all lead to cost inflation. Many different economic conditions can lead to cost inflation, and this may concern policymakers as cost inflation can be difficult to contain.

We discuss the typical causes of cost-push and demand-pull inflation below. For more information on inflation see Definition of inflation and our free inflation calculator Here.

Causes of demand-pull inflation

Demand-pull inflation occurs whenever the amount of goods and services people want to buy increases. Some of the most common causes of demand-pull inflation are:

economic growth: As economies grow and people have more money, they feel more secure in their ability to purchase goods and services. This increases the cost of goods and services as more people can now afford more scarce products.

The inflation expectation: Sometimes when enough people, especially large corporations, anticipate inflation, they raise their prices in anticipation of inflation to come. This expectation itself then causes its own inflation.

government spending: Some people believe that excessive government spending can cause inflation. For example, improved welfare programs that provide people with the money they need to buy basic necessities can easily increase consumers' purchasing power. In addition, some monetary policies, such as printing more money to fund spending, can also contribute to inflation.

Increased export demand: When the demand for exports increases, a complicated situation arises in which the currencies involved in the exchange can both experience some inflation.

Causes of cost pressure inflation

Cost pressure inflation occurs whenever there are cost increases at the supply end of the production chain. This includes situations like:

Raw material costs: Sometimes the prices of raw materials increase. For example, a certain type of metal that a computer manufacturer needs to manufacture computer chips can become scarce. This will increase the cost of the consumer good, the computer, as the business will likely have to spend more money to get the metal it needs. Rising oil prices are another common example – when gas is more expensive, companies have to pay more to ship their products, so they raise their prices.

Labor costs increase: As the price of labor increases, the cost of the goods that labor produces is likely to increase as well. For example, when workers are underpaid, goods and services can be priced artificially low. Then, as workers organize for a fair or living wage and labor costs rise, goods and services can begin to cost more than the artificially suppressed price, leading to inflation.
Unforeseen production obstacles: The goods and services we buy often contain parts from all over the world and require tremendous travel distances to arrive at our local stores. If a country that supplies a particular crop to an American manufacturer experiences a drought, or a hurricane near a major port, or a pandemic that makes it dangerous for workers to work in close proximity to one another, companies can faced with sharp increases in production costs.

In addition to these two general types of inflation, there are also many factors that can affect inflation. We'll go through these next.

Factors that can affect inflation

When policymakers and other experts worry about inflation, the following are some of the most common factors they monitor:

As production costs increase, companies are likely to increase the cost of goods and services as well. As mentioned above, this is one of the causes of cost inflation.

When commodity prices rise (whether due to cost or demand inflation), it is a sign that generalized inflation is emerging throughout the economy.

If the demand for goods increases – for example, because unemployment is low – the cost of goods is likely to increase as well, at least before production can catch up. That could fuel some inflation.

Availability of qualified workers

The availability of skilled labor is another potential source of inflation. When the labor required to manufacture certain products is scarce, the cost of those products is likely to increase.

New technologies often lead to disruptions in economic sectors. Depending on how this goes, this may increase demand for certain products, increase supply, or increase costs anywhere along the supply chain. All of these factors can affect inflation.

The amount of money currently in circulation can also have an impact on the state of inflation. When there is more money in the economy, the relative value of a unit of currency (like $1) can go down. Because of this, some economists believe that printing more money to pay for government spending could lead to inflation.

Countering the effects of inflation

Low inflation is normal in most economies, but rapid inflation can be detrimental to society as people can no longer afford many of the goods and services they depend on. This leads many economists and policy analysts to wonder what causes inflation and how to stop its negative effects.

The way governments can counteract the effects of inflation depends on the type of inflation that is occurring and the factors that are causing it. Economists also disagree on how best to address inflation. It's an area that needs a lot more study.

This isn't particularly helpful if you're dealing with high inflation rates at the present moment. However, that doesn't mean you're completely at the mercy of the economy.

As an individual, there are steps you can take to ensure your money is not affected by inflation:

Invest whenever you can. Money held in a savings account slowly loses purchasing power due to inflation. if you start investing in the stock market, bonds or other high-yield options, you can offset the effects of inflation (while also taking on other risks). Investing in real estate such as Buying a home, for example, can also be an effective way to offset inflation, as real estate often appreciates in value over time.

Ask for a raise. If you haven't had a raise in months or years, chances are your real wages have gone down. That's because your monthly paycheck might not stretch as far as inflation rises. Working and asking for raises to match inflation is one way to offset its effects.
Organize your workspace. If you and your co-workers haven't received a raise, it might be time to think about it organize workplace. By teaming up with your peers and pledging not to work until your wages are increased, you can secure a higher wage and offset the effects of inflation.

According to the Joint Economic Committee, prices are currently rising at their fastest pace in decades, adding to concerns about inflation. While there is no real emergency, now is the best time to take proactive action.

Plan for the future with Mint

If you are curious how your income, debt, investment tracking, and more piling up against inflation, there's one way to keep track: mint. The Mint app allows you to plan your future by consolidating all your various financial information in one convenient place. Join Now and download the app for free today and get an overview of your finances so you can plan for whatever the future holds, inflation or not!

Sources: NPR | US Bureau of Labor Statistics | Joint Economic Committee

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