Inflation can be defined as a continued increase in the mean price of products and services. Excess total demand, as a result, of too rapid economic growth, and supply side factors (cost push factors) are the key causes of inflation.
The causes of inflation are associated with demand pull. Demand-pull inflation is characterized by rise in demand comparative to supply. An economy that is close to or at full employment would be characterized by a rise in demand which would lead to a rise in the price amount. Inflation emerges as firms reach full capacity. In response to firm full capacity, prices are raised; workers get higher wages thereby increasing their spending power. There would be demand-pull inflation, whenever the economic growth surpasses the long run trend rate of growth. The growth in productivity is used to measure the average sustainable rate of growth which is referred to as the long run trend rate of economic growth.
Cost push is one of the main causes of inflation. If the costs of firms are increased, then the firms will apply this to consumers by incorporating the increased cost into their products and services. There are many factors that can cause cost-push inflation, and they include rising wages, import prices, raw material prices, higher taxes, declining productivity, and profit push inflation. A key cause of cost-push inflation is rising wages. It is evident that higher wages is associated with rising demand. Devaluation of currency, which is directly related to an increase in inflation, will result to more expensive import prices. In other words, when there is a depreciation of currency people spend more to purchase the same imported goods. Causes of inflation related to cost-push are also associated with increases in the price of oil. If the oil price increases by 25% then there will be a significant rise in prices of most commodities and services in the economy.
Other Causes of Inflation
Rising in house prices and printing of more money are other causes of inflation. Rising house prices can indirectly trigger demand pull inflation. Moreover, there will be a rise in inflation if the Central Bank prints money more than needed. There will be a rise in prices of commodities if there is more money pursuing the same volume of goods. An extreme increase in the money supply usually causes hyperinflation with exceptional conditions, such as recession and liquidity trap.
The rise in inflation means that investors need to understand gold investing essentials in order to hedge and protect themselves. People need to have ten percent of their money in gold and precious metals in order to have insurance against inflation.