Unexpected price rises can trigger demands for raises, causing more inflation. High inflation, as in periods of “hyperinflation,” can cause the basic functioning of an economy to break down. Central banks track inflation and use interest rates to control prices, aiming for a harmless 2% increase in prices each year.
How is Inflation Measured?
There are a few different measures of inflation, including the Producer Price Index (PPI), GDP Deflator, Personal Consumption Expenditures (PCE) Price Index, and the most commonly used Consumer Price Index (CPI). All of these measures attempt to track changes in the price levels of a series of goods.
Consumer Price Index
The Consumer Price Index (CPI) is the economic indicator of choice for measuring inflation. It tracks the average price of a representative basket of goods and services that households buy, weighted by how much they spend on them. The CPI estimates the importance of each of these goods or services to the average consumer and weighs the price changes to see how much a consumer is paying overall.
Although, economists prefer to look at the “core CPI,” which is the CPI without food and energy prices, as those two categories are volatile and their prices fluctuate considerably from month to month. By looking at the average price level without those two categories, it’s easier to determine if the economy is experiencing an increase in prices.
Producer Price Index
While the CPI measures inflation from the standpoint of the consumer, the Producer Price Index (PPI) measures price changes from the perspective of the producers.
Specifically, the PPI measures the price businesses pay for inputs like fuel, farm products, chemical products and metals. If the price increases that cause the PPI to spike get passed onto consumers, it will be reflected in the CPI.
Gross Domestic Product Deflator
The U.S. Bureau of Economic Analysis (BEA) uses the gross domestic product (GDP) deflator to measure the level of prices of all new, domestically produced final goods and services in an economy by comparing the prices of goods and services produced in a given year to the prices of the same goods and services produced in a base year, resulting in a ratio that represents the overall change in prices from the base year to the current year.
The GDP deflator is considered a more comprehensive measure of inflation than the (CPI) because it includes all goods and services produced domestically, not just those purchased by consumers.
Personal Consumption Expenditures Price Index
The PCE index is another inflation measurement that tracks price changes in the amount spent on consumer goods and services in the U.S. economy, although it includes a wider range of goods and services than the CPI and is weighted by more reliable data from regular business surveys.
Additionally, the PCE index is used to calculate real GDP by adjusting for inflation and by the Federal Reserve to track inflation and make monetary policy decisions.
What Causes Inflation?
Inflation is a complex phenomenon with many possible causes, but it generally occurs when there is too much money chasing too few goods and services.
There are two main types of inflation: cost-push inflation and demand-pull inflation. In understanding the factors that contribute to and define these two types of inflation, we can better understand what causes inflation.
Cost-Push Inflation
Cost-push inflation occurs when prices rise because production costs increase, such as raw materials and wages. Even though the demand for goods stays the same, fewer goods are being made because it costs more to make them. As a result, the added costs of making these goods are passed on to consumers in the form of higher prices.
Signs of cost-push inflation:
- Rising prices of commodities like oil and metals
- Escalating unemployment rates
- Increasing labor costs like wages and benefits
- Inflating prices on finished goods and services
Demand-Pull Inflation
Demand-pull inflation occurs when there is a strong consumer demand for a product or service, causing a surge for a wide breadth of goods across an economy, ultimately increasing prices. While this is rarely a concern for short-term imbalances of supply and demand, sustained demand can reverberate in the economy and raise costs for other goods.
Signs of demand-pull inflation:
- Decreasing unemployment rates and increasing job openings
- Increasing consumer spending and consumer confidence
- Rising prices of goods and services across different sectors of the economy
- Increasing business investments and expansions
In addition to these primary causes, inflation can also be influenced by changes in government policies, global economic conditions, supply shocks and even natural disasters.
When Will Inflation Go Down?
Since the spring of 2021, inflation rates have been high in many countries, including the United States.
COVID-19 pandemic-induced disruptions to supply chains and decreased availability of goods and services have contributed to inflation. Fiscal and monetary policies, such as stimulus spending and low interest rates, were enacted to combat the pandemic’s economic effects but have also contributed to inflation.
The current high inflation rates could lead to reduced purchasing power for consumers, increased costs for businesses, and decreased economic growth. Many experts believe that inflation will decrease as the global economy recovers from the effects of the pandemic.
Stay up to date on relevant government policies, laws and regulations that impact Americans and future generations at PolicyvsPolitics.org. Why is inflation so high? When will inflation go down? These are important questions to ask as Americans have noticed rising prices throughout the economy, from groceries to gasoline, utility bills and house prices, as the COVID pandemic began to recede in 2021.
With a gradual loss of purchasing power, inflation reduces consumer and business confidence and makes it harder for people to make ends meet.
While there is no singular answer as to what causes inflation, it does come down to a mix of output, money, and expectations. Supply shocks and an increase in the money supply can drive up prices, with the expectation of inflation triggering a self-fulfilling cycle.
Continue reading to learn more about inflation, including inflation measurements and types of inflation, as we examine the question: what causes inflation?
What Is Inflation?
Inflation is a complex economic phenomenon that occurs when the price of goods and services increases over time, making the same amount of money buy fewer goods and services.