The Three Main Causes Of Inflation In An Economy

Three (3) things collapsing economies like Ghana have in common

Please Share Me

The rise in prices, which is often expressed as a percentage, means that a unit of currency effectively buys less than it did in prior periods. Inflation can be contrasted with deflation, which occurs when prices decline and purchasing power increases. A country’s money supply can be increased by the monetary authorities like the Bank of Ghana.

The mechanism of how inflation is driven can be classified into three types:

  1. Demand-Pull Inflation
  2. Cost-Push Inflation
  3. Built-in Inflation

Demand-Pull Effect

Demand-pull inflation occurs when an increase in the supply of money and credit stimulates the overall demand for goods and services to increase more rapidly than the economy’s production capacity. This increases demand and leads to price rises.

When people have more money, it leads to positive consumer sentiment. This, in turn, leads to an increase in spending, which pulls prices higher. It creates a demand-supply gap with higher demand and less flexible supply, which results in higher prices.

Cost-Push Effect

Cost-push inflation is a result of the increase in prices working through the production process inputs. When additions to the supply of money and credit are channeled into a commodity or other asset markets, costs for all kinds of intermediate goods rise. This is especially evident when there’s a negative economic shock to the supply of key commodities

These developments lead to higher costs for the finished product or service and work their way into rising consumer prices. For instance, when the money supply is expanded, it creates a speculative boom in oil prices. This means that the cost of energy can rise and contribute to rising consumer prices, which is reflected in various measures of inflation.

Built-in Inflation

Built-in inflation is related to adaptive expectations or the idea that people expect current inflation rates to continue in the future. As the price of goods and services rises, people may expect a continuous rise in the future at a similar rate. As such, workers may demand more costs or wages to maintain their standard of living. Their increased wages result in a higher cost of goods and services, and this wage-price spiral continues as one factor induces the other and vice-versa.

An increase in the supply of money is the root of inflation, though this can play out through different mechanisms in the economy. The above is the very cause of inflation in most economies in the world. So we confidently say higher inflation rates not only depend on mismanagement of an economy or external factors but the behavior of the citizenry.


Please Share Me

2 thoughts on “The Three Main Causes Of Inflation In An Economy

Leave a Reply

Your email address will not be published.