The 6 main causes of inflation – simply explained

To ensure that your money follows inflation, you should save and invest your money whenever possible.
Rachel Mendelson / Insider

Inflation is the increase in the price of goods and services over time.

A change in inflation is due to a number of factors. For example, due to the increase in production costs.

Inflation is measured monthly using the consumer price index.

From used cars to the real estate market to the stock market, inflation has always played an important role for people. Because if prices rise over time, the purchasing power of the euro will slowly decline. However, rising and falling inflation can have different causes depending on the economic situation.

What is inflation?

Inflation is the increase in the price of goods and services over time. Inflation causes your purchasing power to fall. Means: with the same euro today you can buy less in the future.

“The simple story is that too much money is being spent on too few goods and services,” says Dean Baker, senior economist at the Center for Economic and Policy Research in Washington, USA.

Current inflation

The inflation rate in Germany was 7.6 percent in June 2022, according to the Federal Statistical Office. To calculate inflation, first create a “shopping cart” of goods and services. The price level of this “shopping cart” is what is measured from month to month. This shopping cart is intended to capture some of the goods and services that urban households typically consume. Based on this basket, the consumer price index is created, and the current value of the basket is determined by adding the individual totals together.

The next step is to compare the price of the current basket with the same basket in the so-called base period. Inflation is then calculated on the basis of the change in the price level of the curve in the base period compared with the curve in the most recent period.

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What are the causes of inflation?

Inflation can be caused by various factors. The most common factors are inflation on the demand side and inflation on the cost side.

Here are the main reasons for inflation:

1. Demand inflation

Demand-pull inflation occurs when demand for certain goods and services exceeds the economy’s ability to meet that demand. When demand exceeds supply, there is upward pressure on prices, causing inflation.

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2. Cost inflation

Cost-push inflation is the rise in prices as labor and material costs rise. These costs are often passed on to consumers in the form of higher prices for these goods and services. An example of this would be timber as it is a primary product for building houses. When the price of timber increased by 400 products in 2021, this affected the rise in property prices and led to inflation.

3. Increased money supply

The amount of money is defined as the total amount of money in circulation, which includes cash, coins, balances and bank accounts. If the money supply increases faster than the rate of production, this can lead to inflation, especially demand inflation, as too many dollars are spent on too few products.

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4. devaluation

A devaluation is a downward adjustment of a country’s exchange rate. This leads to a lower value of a country’s currency.

Devaluation of a currency makes a country’s exports cheaper, which encourages foreign countries to buy more of the devalued goods. Devaluation also makes foreign products more expensive for the devaluing country, leading to citizens of the devaluing country buying domestic products over foreign imports.

5. Rising wages

Rising wages are exactly what it sounds like – a wage increase for workers. “Salary is a cost of production,” Baker adds. “When wages rise sharply, companies must either pass on costs or live with reduced margins. The exception is when they can offset the wage increase with higher productivity. ”

However, economists disagree on the impact of incremental wage increases, such as raising the minimum wage, as opposed to a faster, sudden wage increase. Some believe that a wage increase can lead to expensive inflation due to the higher costs for companies. While others believe that higher wages across the board, and not just in certain sectors, demand is also increasing enough to offset a price increase.

“Rising wages should allow consumers to fight inflation, especially if wages grow at the same rate or faster than inflation,” said Susane L. Toney, a professor of business and economics at Hampton University. “Rising wages allow consumers to pay higher prices without affecting their purchasing power.”

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6. Policies and rules

Certain policies can also lead to cost- or demand-side inflation. If the government provides tax subsidies for certain products, it may increase demand. When demand is greater than supply, costs can rise. In addition, strict building regulations and even rent stabilization measures can inadvertently increase costs and create an inflationary environment by passing these costs on to residents or artificially reducing the supply of housing.

The economic consequences

Inflation, which is generally around 2 percent per year, is a normal part of our economic system. Under normal economic conditions, this means that your money is worth less each year, unless it is compounded at a rate greater than or equal to inflation. Annual wage increases or cost-of-living adjustments from your employer can ensure that your money keeps pace with inflation.

“Keep in mind that inflation tends to be uneven,” Baker adds. “Some prices rise rapidly, while others may remain stable or even fall. This may be an opportunity to save money by waiting for better prices or finding a replacement product or service.” Investing your money is also an important tactic. For the interest rates you get on your savings accounts, “probably do not cover the rising prices,” the financial expert believes.

This article was translated from English by Leo Ginsburg. You can find the original here.

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