Jacky bought a loaf of bread at one dollar in April, in May she bought a loaf of bread from the same vendor at one dollar but the loaf of bread was not as big as the latter. Jacky asks the vendor “why is the loaf smaller this month?” The vendor replied “the prices of goods have gone up”. This is an example of inflation, a continuing rise in the general price level of goods and services over a period of time in an economy. While inflation can help stimulate economic activity, too much can destroy it. So, what causes inflation? Continue reading to find out.
Causes of inflation
Inflation can be caused by multiple factors with demand-pull and cost-push inflation being the most common. However, the causes of inflation in 2022 are a bit more complex and have been caused in part because of the government’s response to the pandemic, in addition to sudden increases in demand as coronavirus lockdown restrictions faded and as labour shortages occurred across the country as well as conflict between Russia and Ukraine and sanction placed by the international community.
Here are the major causes of inflation:
- Demand-pull inflation
Demand-pull inflation happens when the demand for certain goods and services is greater than the economy’s ability to meet those demands. When this demand outpaces supply, there’s an upward pressure on prices causing inflation.
- Cost-push inflation
Cost-push inflation is the increase of prices when the cost of wages and materials goes up. These costs are often passed down to consumers in the form of higher prices for those goods and services.
- Increased money supply
Increased money supply is defined as the total amount of money in circulation, which includes cash, coins, and balances and bank accounts according to the Federal Reserve. If the money supply increases faster than the rate of production, this could result in inflation, particularly demand-pull inflation because there will be too many dollars chasing too few products. An increase in money supply is usually created by the Federal Reserve through a process called Open Market Operations (OMO).
Devaluation is downward adjustment in a country’s exchange rate, resulting in lower values for a country’s currency.
The devaluation of a currency makes a country’s exports less expensive, encouraging foreign nations to buy more of the devalued goods. Devaluation also makes foreign products for the devaluing country more expensive which encourages citizens of the devaluing country to buy domestic products over foreign imports.
- Rising wages
Rising wages is an increase in what’s being paid to workers. Wages are a cost of production. As wages rise, businesses will either have to pass the cost on to customers, or do with low profits.
- Policies and regulations
When the government issues tax subsidies for certain products, it can increase demand. If that demand is higher than supply, costs could rise. Additionally, stringent building regulations and even rent stabilization policies could inadvertently increase costs and create an inflationary environment by passing those costs to residents or artificially reduce the supply of housing.
Effects of Inflation
Negative Effects of Inflation
1. Money Loses its Value
As the prices of products go up, money loses value. For instance, if you keep $1 under your pillow for one year, you will not be able to buy as much as you could today due to inflation.
Inflation can predominantly hurt low-income households. They spend most of their income, so price increases usually take up more of their incomes. For instance, when the price of necessities such as food and housing go up, the poor have no choice but to pay.
One of the effects of inflation is that asset prices tend to rise. Assets such as housing, the stock market, and commodities such as gold tend to outstrip inflation.
This increases inequality as richer households have more assets. They own more property, shares, and other assets. What this means is that when inflation occurs, these assets increase in price ahead of ordinary goods such as bread, milk, eggs, etc. As a consequence, they end up with wealth that can buy them more goods and services than previously. At the same time, low-income households have to spend more just to get by.
3. Increased Cost of Living
As prices of goods increase, it goes without saying that consumers will have to pay more in order to buy basic necessities and luxuries alike. This may not necessarily be a problem if incomes rise in line with inflation, but those who don’t will face higher real prices. In other words, they will have to spend a higher percentage of their income on the same number of goods.
Positive Effects of Inflation
1. Increased Spending and Investment
As inflation increases, consumers are incentivized to move purchasing decisions forward. Rather than wait until next year when the product will be more expensive, consumers rationally elect to buy now than pay more next year.
2. Reduces Effective Level of Debt
Whether it’s a business, the government, or the consumer, those who have high levels of debt may in fact benefit from having higher levels of inflation. For example, the borrower may have an interest rate of 2 percent on their debt. If inflation is at 10 percent, and their income increases at a similar rate, it means the effective rate by which they are repaying declines.
3. Higher Asset Prices
Segments of society which own physical assets such as property, stock etc. benefit from the price / value of their holdings going up
How can you cope with inflation?
To ensure that your money is keeping pace with inflation, consider annual salary increases or cost of living adjustments by your employer.
If you’re an entrepreneur, consider raising your rates incrementally. On the consumer side: Remember that inflation is typically uneven, some prices rise rapidly, while others can be stable or even falling. This may be an opportunity to save money by waiting for better prices or finding a substitute item or service.
Investing your money is also an effective tactic to beat inflation as well. Hedges for inflation may include corporate bonds and dividend paying stocks and index funds.
We have learned a few things about inflation, its causes, its negative effects and positive effects and how we can cope with inflation.
Inflation is viewed as positive when it helps boost consumer demand and consumption, driving economic growth. Some believe inflation is meant to keep deflation in check, while others think inflation is a drag on the economy.
Well, I believe inflation is a drag on the economy, especially after a pandemic such as the Covid-19. Estimates indicate the virus reduced global economic growth in 2020 to an annualized rate of around -3.2%, with a recovery of 5.9% projected for 2021. Global trade is estimated to have fallen by 5.3% in 2020, but is projected to grow by 8.0% in 2021. However, a recovery being estimated in 2021. Prices go up with 14% to 25% due a so-called oil crisis in 2022. This is making the expenditure extremely higher and will make the day-to-day living for the average person unbearable. Keeping prices restrain is preferable for any party involved in the world economy.
What do you think is the current cause of inflation in your country and how are you going to cope with it? Let me know your thoughts in the comment section.
 Jackson, J. K., M, Weiss, M. A., Swarzenberg, A. B., Nelson, R. M., Sutter, K. M., & Sutherland, M. D. (2021, November 10). Global economic effects of covid-19. Retrieved April 18, 2022, from https://sgp.fas.org/crs/row/R46270.pdf
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