Causes of Inflation

Inflation is caused by several factors, which can broadly be classified into demand-pull inflation,
cost-push inflation, and built-in inflation. Here are the key causes:
1. Demand-Pull Inflation:
- Increased consumer demand: When the demand for goods and services exceeds their supply.
- Government spending: High levels of government expenditure can boost overall demand in
the economy.
- Monetary policy: Expansionary monetary policies, such as lower interest rates, can increase
money supply and consumer spending.
2. Cost-Push Inflation:
- Rising production costs: Higher costs for raw materials, labor, and other inputs can lead to
increased prices for finished goods.
- Supply chain disruptions: Problems in the supply chain, such as natural disasters or
geopolitical conflicts, can reduce the supply of goods and drive up prices.
- Exchange rate fluctuations: A weaker national currency can make imported goods more
expensive, contributing to inflation.
3. Built-In Inflation:
- Wage-price spiral: As workers demand higher wages to keep up with rising living costs,
businesses may increase prices to cover higher wage costs, creating a cycle of wage and price
increases.
- Inflation expectations: If businesses and consumers expect prices to rise in the future, they
may adjust their behavior accordingly, such as demanding higher wages or increasing prices
preemptively, thus perpetuating inflation.
4. Other Factors:
- External shocks: Events such as oil price shocks or significant changes in global commodity
prices can lead to inflation.
- Fiscal policies: Deficit financing and excessive borrowing by the government can contribute
to inflation if they lead to an increase in the money supply.

Effects of Inflation
Inflation has various effects on the economy, which can be both positive and negative. Here are
some of the key effects:
1. Decreased Purchasing Power:
- As prices rise, the value of money decreases, meaning consumers can buy less with the same
amount of money. This reduces the purchasing power of individuals and households.
2. Cost of Living Increases:
- Higher prices for goods and services lead to an increased cost of living, which can
particularly impact low- and fixed-income households.
3. Interest Rates:
- Central banks may raise interest rates to control inflation, which can lead to higher borrowing
costs for consumers and businesses. This can reduce investment and spending.
4. Wage-Price Spiral:
- As the cost of living rises, workers demand higher wages. If wages increase, businesses may
raise prices to cover higher labor costs, creating a cycle of wage and price increases.
5. Uncertainty and Planning Difficulties:
- High or unpredictable inflation can create uncertainty, making it difficult for businesses and
consumers to plan for the future. This can reduce investment and economic growth.
6. Redistribution of Wealth:
- Inflation can redistribute wealth between different groups. Borrowers may benefit because the
real value of their debt decreases, while savers lose because the real value of their savings
erodes.
7. Impact on Exports and Imports:
- If a country experiences higher inflation than its trading partners, its goods and services
become more expensive relative to foreign products. This can reduce exports and increase
imports, potentially leading to a trade deficit.
8. Menu Costs:
- Businesses may face increased costs as they need to update prices more frequently (e.g.,
reprinting menus, price lists).
9. Shoe Leather Costs:
 - High inflation can lead to increased costs for consumers as they spend more time and effort
managing their money to avoid losses due to inflation, such as frequently transferring funds
between accounts or searching for better interest rates.
10. Hyperinflation:
- In extreme cases, very high and typically accelerating inflation can lead to hyperinflation,
causing a collapse in the currency’s value and severe economic instability.
While moderate inflation is often considered a normal part of economic growth, high or
unpredictable inflation can have significant negative impacts on an economy.