What causes inflation? | family finance

Hyperinflation can be very harmful to consumers, but deflation is also considered undesirable by economists. Causes of inflation – and how severe it is Factors that lead to inflation Affect consumers – varies and has historically been the subject of much debate among economists.

However, inflation itself is expected.

“Inflation is normal,” says Brian O’Leary, wealth advisor and chief analyst at ALINE Wealth. There is no need to fear the fact that inflation exists and, in fact, is healthy in the economy. The issue becomes the appropriate amount of inflation.”

What causes inflation?

Inflation is caused by factors such as pressures on the supply or demand side of the economy, money supply policies and even consumer expectations.

Economists define inflation as the rate of increase in prices over a given period of time. It is usually a general measure indicating the overall increase in prices or cost of living in a country. Its causes can vary, but a rise in prices in a particular sector does not necessarily indicate widespread inflation.

“The price of any given commodity going up or down isn’t inflation,” says Michael Rosen, chief investment officer at Angeles Investment Advisors. “Inflation is caused by an imbalance between supply and demand in money, and not by an imbalance between supply and demand for a particular good, such as the cost of a plane ticket or Price at the pump. “

The reason for the high rate of inflation today is partly due to factors linked to the coronavirus pandemic. The CPI rose only 2.3% from 2018 to 2019 – close to the Federal Reserve’s 2% inflation target. But as the economy begins to recover from the effects of the pandemic and various government efforts to stimulate the economy during the pandemic continue, the annual report The CPI was 8.5% in March.

“We had a year-and-a-half period where most people were locked into their homes and saving more than usual,” says Gary Zimmerman, managing partner at Six Trees Capital in New York and founder of MaxMyInterest.com. “Now they want to go out and spend, and they are willing to spend more. Until this novelty wears off or until prices go up to a level where it really starts to affect demand or consumption, we will continue to see very high levels of inflation.”

Types of inflation

Periods of inflation can occur unexpectedly as a result of global events, such as the pandemic or the Russian invasion of Ukraine. But there are generally three types of inflation:

  • Demand contributes to inflation.
  • Inflation is rising costs.
  • internal hypertrophy.

Demand contributes to inflation It is characterized by an increase in market demand which supply cannot satisfy along with a low or low rate of unemployment. This type of inflation often results from higher wages, higher home prices, and lower interest rates.

Inflation is rising costs It is characterized by rising commodity prices and is often caused by higher production prices or higher raw material costs.

The third common type of inflation is related to consumer expectations.

“People are starting to recognize that inflation is more than transient, and that, in and of itself, is important because inflation can be self-sustaining,” Zimmerman says. “If there is a view that inflation is temporary, then suppliers and retailers will be reluctant to increase their prices, but once the narrative develops into, ‘inflation is here to stay,’ it gives businesses and their supplies cover to start raising prices.”

How do governments respond to inflation?

Central banks are often tasked with maintaining price stability. For example, the Fed has so far responded to today’s high inflation rates raise interest rates 0.25% in March in an effort to cool an overheated economy.

Governments have a number of levers that they have to pull when trying to control inflation. Deflationary policies, which aim to reduce the rate of inflation, include raising interest rates, fixing the exchange rate by linking the value of one currency to another and price-fixing procedures.

One of the most widely cited historical examples of governments that tried – and in many ways failed – to control inflation is the period of the 1970s and 1980s, known as the Great Inflation. During this period, the inflation rate was 13.5% on an annual basis.

There was considerable debate at the time, Rosen says, about the causes of inflation and how to best respond that mimics the conversations that have been revolving around inflation today.

“There was a lack of basic understanding that supply and demand are the real cause of inflation, and you see the same kind of discussion today,” Rosen says. “It’s hard to tell just about everyone how bad economic conditions in the 1970s and 1980s were with the data. We are not even close to those conditions today… but the similar thing is that the Federal Reserve was slow to tighten policy and tighten the money supply in the face of rising demand.”