What Drives Inflation?
Cause of inflation are various factors which influences inflation in economy. Inflation is result of increase in production cost, demand and supply, wages, pricing power etc.
- Wage inflation
- Pricing power inflation
- Expansionary fiscal policy
- Cost push inflation
- Demand pull inflation
1. Wage Inflation
Wage inflation is one cause of inflation. Wage inflation is rise in wages of workers. That means workers get higher pay. Hike in wages, increases the purchasing power of workers that affects the demand and price of goods and services. Wage inflation infuse the money in market and it increases cost push inflation and demand pull inflation.
2. Pricing Power Inflation
Pricing power inflation is second cause of inflation. Pricing power inflation is rise in prices of goods and services. This inflation occurs when money flow in market increases. Money flow will increase the purchasing power, which will increase demand and scarcity of goods and services. Pricing power inflation also increases cost push inflation and demand pull inflation.
3. Expansionary fiscal policy
Expansionary fiscal policy is third cause of inflation. Fiscal policy is regulated by government. Objective of fiscal policy is to influence the economy growth of nation by using government revenue collection and expenditure. Government use expansionary fiscal policy during the contraction phase in the business cycle and economy. Government use expansionary fiscal policy to stimulate the business cycle and economy by increasing expenditure in form of giving employment, infrastructure development (e.g. building hospitals, schools, highways, government buildings etc.) and giving tax rebate for individuals as well as business entities.
Expansionary fiscal policy infuses the money in market, which increases the purchasing power. Increase in purchasing power stimulates the cost push and demand pull inflation.
4. Cost Push Inflation
Cost push inflation s fourth cause of inflation. Cost push inflation is a consolidated result of wage inflation and pricing power inflation. Inflation in both wages and price of raw material increases the production cost. Increased production cost is passed onto consumers creating cost-push inflation. If a company’s production costs rise, company pass on the additional costs onto consumers by raising the prices for their products.
5. Demand Pull Inflation
Demand pull inflation is fifth cause of inflation. Inflation which is driven by demand is called demand pull inflation. Demand pull inflation is also consolidated result of wage inflation and expansionary fiscal policy which increases the money flow in market and boost the purchasing power of people. Increase in purchasing power tends to increase the demand. Demand-pull inflation is the upward pressure on prices that follows a shortage in supply. This imbalance in high demand and short supply creates a pressure of inflation on goods and services. Economist describes demand pull inflation as “too many dollars chasing too few goods.”
What are all phases in Inflation cycle?
- Inflation
- Stagnation
- Dis- Inflation
- Deflation
- Reflation
- Stagflation
- Recession
- Depression
- Bottleneck Inflation
- Skewflation
Inflation
“A sustain increase in the general price level of basket of selected goods and services in an economy over the period of time is called Inflation.”
Inflation means continuous growth in price of goods and services over the period of time. Growth in general price level, decreases the purchasing power of currency. When inflation rises, every rupee buys a smaller quantity of goods and services.
Developing economy has a excellent growth cause of inflation.
Stagnation
Stagnation is a phase of stability. During the stagnation no or little growth in inflation rate. In this phase inflation rate gets stable either with no positive growth (flat) or have extremely slow positive growth. Stagnation is a condition of slow or flat growth in an economy. Economy gets stable cause of inflation stagnation phase.
Dis- Inflation
Reduction in the rate of change in inflation rate is called Dis- Inflation. Dis- Inflation means slowdown in the pace of price inflation of basket of selected goods and services over the period of time. In dis- inflation, CPI increment pace slows down from the previous period when the prices were rising. In dis inflation, inflation declines to a lower rate but is still positive.
Deflation
Decrease in general price level of goods and services. Deflation occurs when the inflation rate falls below zero percent (0%). Deflation increases the value of currency that increases the purchasing power of currency. When deflation rises, every rupee buys a larger quantity of goods and services. Negative inflation is called deflation.
Reflation
Reflation is an artificial inflation which is artificially created by controlling the monetary or fiscal policy. In reflation government and central bank tries to stimulate the economy by infusing the money or reducing the taxes for increasing the money supply in the market.
Objective of stimulation is to bring the economy back up to the long term trend. Reflation is opposite of dis-inflation and considered as a form of inflation.
Reflation is an attempt to convert the dis-inflation in to inflation or in other words reflation is an attempt to preventing the transformation of dis-inflation into deflation.
Stagflation
Stagflation is a phase of dilemma in economy. Stagflation is a condition of economy where inflation rate is high, economy growth rate is slow, and unemployment rate goes up. There are three causes which creates the situation of stagflation.
- High money supply in market
- Shortage of supply
- Industry crisis
Money supply increases the demand of goods and services. Demand pulls the prices of goods. Industry crisis, demand pull situation and high prices creates the shortage of supply. Due to industry crisis, production decreases and production cost increases. High production cost, low production and less profit margin tends to slow economic growth. Profit margins decreases cause of inflation in raw material, wages of workers, etc. Unemployment increases due to Industry crisis and less profit margin. This situation transforms into recession.
Recession
A significant decline in economic activity spread across the economy for more than a few months. Recession clearly visible in real Gross Domestic Product, real income, employment, industrial production etc. Recession is a slowdown in economy for more than two or more quarters.
Depression
Depression is an economic phase where recession spreads for long lasting more than two year. Depression is a very severe phase of recession, economy downtrends, large unemployment, financial crisis, banks failure etc.
Bottleneck Inflation
Name of Bottleneck inflation itself explains the situation where drastic fall in supply but demand remains at same level. This situation arises due to crisis, accident or mismanagement in supply chain or production planning. Drastic decrease in supply but demand remains on same level that is called bottleneck inflation.
Skewflation
Skewflation is a mid-situation of inflation and deflation. In skewflation phase of economy some sectors are facing huge inflation, some are facing none and some sectors are facing deflation. This mixed situation of economy is called skewflation.