What is inflation and why is it rising?
What is inflation? Inflation is the general increase in the prices of goods and services in an economy. Economies around the world have always been familiar with inflation, and so have consumers who are directly impacted by rising inflation.
In the past 61 years in the United Kingdom, inflation rates have hovered between 0.4% and 24.2%, according to World Data. In the United States, inflation averaged at about 3.27% from 1914 until 2022, reaching an all-time high of 23.70% in June of 1920 Trading Economics has said.
Discover everything you need to know about inflation with WorldRemit.
WorldRemit Content Team
• 6 mins read • Updated
Definition of inflation
There are two main definitions of inflation. Inflation is a situation when prices rise in the economy. A more exact definition is that inflation is a sustained increase in the general price level in an economy.
Inflation can cause a cost of living increase as the price of goods and services rise. You may also wonder, “what is an inflation rate?” The rate of inflation measures the annual percentage change in the general price level, according to EconomicsHelp.org.
Inflation generally means that your money won’t buy as much today as it did yesterday.
What is the cause of inflation?
The three main causes of inflation are the following external factors: production costs, demand and fiscal policies.We can identify the different types of inflation and what causes them. Read on to find out what they are.
Demand-pull inflation
What is demand-pull inflation?
You may ask yourself “What is demand-pull inflation”, well it is what happens when there are “too many dollars chasing too few goods.” In other words, it’s the upward pressure on prices that follows a shortage in supply, Investopedia says.
What causes demand-pull inflation?
Some of the reasons for this effect coming into play include:
A growing economy - One sign of a strong economy is consumer confidence. They’ll spend more and take on more debt. But on the flip side, this leads to an increase in prices and demand.
Increasing export demand - When exports rise, the currencies involved in their trade can become devalued.
Government spending - In some countries, increased government spending can cause prices to rise.
Inflation expectations -Some companies may expect that inflation will increase soon – they’ll then raise their prices to match.
More money in the system - “Printing money” is one problem that can cause inflation because when the money supply is abundant with too few goods to buy, prices will inevitably rise.
That doesn’t mean, in every instance, that these factors will definitely cause inflation in a given country. But these are the sorts of levers that can be pulled to influence an economy in a particular way – which, at times, can cause inflation.
Cost-push inflation
What is cost-push inflation?
Cost-push inflation occurs when the economy experiences rising prices due to higher production and raw materials costs. It’s determined by supply-side factors such as higher wages and higher oil prices.
This type of inflation can lead to lower economic growth and often causes a temporary fall in living standards, according to EconomicsHelp.org.
What causes cost-push inflation?
The Balance gives a few reasons for this type of inflation:
Wage inflation - This is when companies pass through the higher wage costs of their workers on to consumers
Increase price of raw materials and energy prices - When it costs more to produce a product, the price of that product will inevitably increase
Natural disasters - The depletion of natural resources, either through a disaster or overconsumption, is one factor in causing cost-push inflation
Government regulation and taxation - Some regulations can reduce the supply of certain products, resulting in inflation
Exchange rates - A country which allows its currency value to fall will experience higher import prices. To find out more about exchange rates, read our blog on the topic
The housing market
Housing market inflation is when housing prices increase including the loans to buy houses (mortgages).
You may have already noticed how housing prices have gone up significantly since the post-war period. In the nineties and noughties, in particular, demand for houses has gone way up. And in countries like the UK, there has long been a shortage of supply in terms of housing. So even a slight increase in demand can cause a significant rise in housing costs, according to Rightmove.
Built-in inflation
Built-in inflation is what happens when people expect current inflation rates to continue into the future. For example, as the costs of goods and services rise, workers may also expect their wages will rise at the same rate for them to enjoy the same standard of living.
By increasing these wages, employers often end up with higher costs of goods and services which creates a wage-price spiral in which the two factors feed off each other. This makes built-in inflation a type of double-edged sword.
Fiscal policies
Fiscal policy is when a country’s government adjusts its spending or taxation rate to influence the nation’s economy. Stimulating a stagnant economy by spending or lowering taxes can sometimes lead to inflation.
The idea is to find a balance between tax rates and public spending, Investopedia suggests.
How is inflation measured?
There are different ways to measure inflation including CPI – or Consumer price index – and PPI which stands for Producer price index. These will help you figure out what the average inflation rate is.
Consumer Price Index (CPI).The consumer price index measures the price of goods and services, such as food or utilities. It’s a measure that helps assess the cost of living in a particular country.
Producer Price Index (PPI).The producer price index measures the prices which impact domestic producers, such as fuel, farming, chemical products, and metal.
How do governments fight inflation?
According to Investopedia, governments can use the following methods for controlling inflation:
Price controls - Price caps mandated by the government for specific goods
Contractionary monetary policies - Controlling interest rates to reduce the money supply within an economy
Discount rates - The interest rate charged on federal loans to banks
Federal funds rate - The rate at which banks lend each other money overnight
Reserve requirements - The amount of money that banks are legally required to keep on hand to cover withdrawals
Open market operations - The buying and selling of Treasury securities
Inflation in 2022
According to the Organisation for Economic Co-Operation and Development, the consumer price index has risen by 9.2% year-on-year as of April 2022. This is partially down to food prices increasing significantly, reaching 11.5% in 2022.
Services prices also increased by 4.4% across the 33 OECD countries. However, the causes of inflation in each country differ slightly. Some, like France, Germany, the UK and Italy, experienced rising energy prices. While others are more affected by the food and service prices.
Of course, all of the types of inflation-related effects are at play within these countries. Some will experience rising house prices as demand increases, while others may suffer from fiscal policies which have negatively impacted the economy. You can often find out what the rate of inflation is within your country on your government’s website.
Coping with inflation
As we’ve mentioned, inflation directly impacts consumers. That means combating the effects of inflation will have a direct effect on your day-to-day life.
You can help cope with these impacts by reducing your individual spending on things like subscription services or home goods items that you don’t really need. You can also employ some financial management tips such as creating a budget for you and your family.
Support your loved ones around the globe
Want to support your loved ones around the world with the rising cost of inflation? You can easily send a money transfer to them using the WorldRemit website or app. We keep our services fast and low cost to make things easier for you, every time you send.
You can also have a look at some of our other blog content to find out more about how to manage your finances:
Inflation: FAQs
What is an example of inflation?
One example of inflation is when salmon are overfished. This leads to a dip in supply, but demand remains high, causing cost increases. Another example is when an area is a very popular place to live, causing an increase in demand and house prices to rise.
Does printing money cause inflation?
Yes, it does. More money in circulation doesn’t change the cost of goods and services. But because households will have more money to spend on those goods, companies may increase the prices to meet the demand.
Who benefits from inflation?
Inflation allows borrowers to pay lenders back with money worth less than what was originally borrowed, so it then directly benefits the borrower.
This communication is intended for marketing purposes only and does not constitute or provide legal, tax, investment or financial planning related advice
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