If you look at this graph of where I live, New Zealand’s inflation over the past 10
years is suddenly heading upwards, but if we zoom out from 1920 to the present, you’ll
see this isn’t the highest it’s ever been.
And on a global level, most countries have seen inflation skyrocketing too.
But was do headlines of inflation being 7.3% actually mean?
What is inflation, and why is it happening?
Inflation in a sense is the decrease in purchasing power, meaning your dollar won’t go as far
as it used to.
Inflation can be a concern, with your saved money being less valuable over time, but gradual
inflation in an economy is expected with most countries having a target of around 2% annually.
As businesses grow, more workers are hired, unemployment falls and households have more
money to spend - inflation is a natural side effect of economic expansion.
When we hear that inflation is up X percent, this is typically on an annual level, comparing
year over year.
Fixed baskets of goods made up from typically around 11 groups, ranging from food and education
costs, to healthcare and transport, are tracked to see the changing prices of good over time
and provides a measure of inflation.
The cause of inflation is often up for debate among economists, but there are two primary
types of inflation from Keynesian economic theories which are fairly widely recognised
but still debated: cost-push inflation and demand-pull inflation.
Cost-push Cost-push inflation occurs when production
costs increase but the demand for goods does not change.
Production costs are mostly made up of the four factors of production, land, labour,
entrepreneurship and capital.
Cost-push inflation sees the added costs of a companies underlying inputs into their production
getting passed on to consumers.
Examples of what can cause this are natural disasters, which can reduce the amount of
raw materials.
Low unemployment rates - due to employers having to raise wages to attract talent - which
is what is currently occurring in many job sectors.
Or commonly used commodities such as semiconductors, oil and metal prices rising which are used
in most major production pipelines.
Government regulation changes can also cause cost-push inflation, for example, new mandates,
such as hypothetically “all employees must have healthcare” or tax increases causing
production prices to increase as it is an added cost for companies to have to compensate
for.
Demand-pull Demand-pull inflation occurs when there is
high consumer demand, but not enough supply.
Unlike cost-push which is influenced from factors of production, demand-pull is influenced
by the four factors of the macroeconomy: households, businesses, governments and foreign buyers.
This sees these four sectors essentially bidding prices up, competing to purchase a limited
amount of goods.
Economists describe demand-pull in a sentence as, ”too many dollars chasing too few goods”.
Because demand is outpacing supply, prices go up.
Stimulus checks can be seen as a recent example where demand-pull inflation could be happening,
as too much money can end up going towards too few goods.
Demand-pull inflation is also linked to low unemployment levels, which is a positive thing,
but leads to more people having disposable income to spend, but production may not be
able to initially keep up with this.
Inflation can be controlled by a country's central bank raising the interest rate it
charges on loans and advancements to commercial banks, which in turn gets passed on to us.
By raising it, the goal is to slow down the economy, because higher interest rates mean
higher borrowing costs meaning people are likely to spend less - which sees the demand
for goods and services fall.
Different countries have different terms for this rate, with New Zealand and Australia
having Official Cash Rate, the US having Federal Funds Rate and UK having the official bank
rate.
What’s behind current inflation?
The current inflation we’re seeing is primarily due to two factors, the pandemic and then
Russia’s invasion of Ukraine has aggravated the issue.
Over the start of the pandemic, tens of millions across the world lost their jobs, with companies
cutting jobs or having to shut down factories due to restrictions, and consumers stayed
home due to lockdows, causing sales to plummet.
This didn’t last long though, and consumers were back out shopping and spending money
but businesses were struggling to meet this sudden demand with them not being able to
hire quick enough, seeing global supply chains across the world fall apart..
With cargo ships stuck in ports with a lack of workers, high demand and general shortages,
the price of gasoline is a great example of something which has skyrocketed and also caused
things such as food, airfares and general goods to rise in prices too, due to them being
reliant on fuel.
Stimulus packages around the world have also been linked to adding to part of current inflation
levels, adding to the issues with excessive demand compared to available goods post initial
lockdowns - basically introducing a sudden influx of hundreds of billions of dollars
chasing too few goods.
The Federal Reserve Bank of San Francisco estimates that stimulus packages in America
may have added three percentage points to America’s current national inflation rate.
While Russia’s economy is pretty small, its commodities are pretty significant for
the world.
Sanctions on Russian oil has seen supply get constrained.
Ukraine also produces a large amount of crops, which with the invasion of Ukraine by Russia
has seen this supply dwindle, causing a lack of goods and prices to rise.
Thanks for watching.