24 Causes of Inflation (with Examples)

The major causes of inflation are uncontrolled public expenditure leading to excess money supply, depreciation of the local currency, increase in indirect taxes, imported inflation, natural disasters, unreliable energy supply, external global events and low agricultural production due to factors such as bad weather and lack of farming inputs.

But the above are far from being the only causes of inflation.

In this tutorial, I will explain, with examples, the major causes of inflation in a country. The majority of the factors responsible for high inflation rates are applicable to almost every country in the world.

In the process, therefore, you will learn a great deal about the causes of inflation not only in advanced countries like the US, Canada and the United Kingdom but also in developing countries such as Ghana, Nigeria, Brazil and South Africa.

We shall begin with a brief definition of inflation as an economic concept.

What is inflation?

Inflation is a gradual but persistent increase in the prices of goods and services over a given period of time, usually a year.

Put differently, inflation is the rate of increase in prices over a given period of time.

Types of Inflation

The two major types of inflation based on the factors that are responsible for the continuous increase in prices are demand-pull inflation and cost-push inflation. Other types of inflation under this category are bottlenecks inflation and in-built inflation

Inflation may also be classified with regard to pace or the extent of its intensity. Thus, we have creeping inflation, walking inflation, galloping inflation and hyperinflation.

Causes of Inflation

There are several causes of inflation in an economy. In this tutorial, I will explain to you the major causes of inflation based on the various types of inflation.

We shall be looking at specific government policies and other resulting economic conditions that could lead to inflation.

Let’s start with the causes of demand-pull inflation.

Causes of Demand-Pull Inflation

Demand-pull inflation is a situation of too much money in circulation chasing fewer goods. This situation arises when consumers have access to higher disposable incomes that significantly increase their purchasing power.

But at the same time, supply conditions are not good enough to keep up with the spiralling demand.

Shortages are bound to happen when the demand for goods and services is greater than their supply. This naturally puts pressure on prices making them spiral out of control.

Significant Increase in Money Supply

The primary cause of demand-pull inflation is, therefore, a significant increase in money supply. Two major factors responsible for an increase in money supply in an economy are monetary policy and fiscal policy.

Government monetary and fiscal policies that cause a significant increase in money supply often result in inflation getting out of control.

Apart from these two, however, other factors such as a rapid increase in the population of a country can also result in demand-pull inflation.

We will look at all three.

Monetary Policy and Demand-Pull Inflation

Below are instances where monetary policy can become a major cause of demand-pull inflation.

1. Lowering Interest Rates

Reducing interest rates below a certain minimum can increase borrowing and spending on the part of the government, firms and households.

The resulting increase in money supply can lead to more money chasing fewer goods thereby driving up prices.

2. Printing of More Money

When the central bank of a country prints more money than the economy can support, the excess money in circulation can lead to inflation.

This is mainly because the increased purchasing power that consumers now have is not a result of an increase in economic activity and output.

In fact, supply remains the same in the face of increasing demand. The likely effect is price increases.

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Fiscal Policy and Demand-Pull Inflation

Government fiscal policy may end up putting too much money in circulation without an immediate corresponding increase in the supply of goods and services.

Increased Public Expenditure

Fiscal policy measures that cause a significant increase in government expenditure can cause prices to rise. Below are instances of increased public expenditure that are among the known causes of inflation around the world.

3. Wage Increases

When the government spends more money on wages, it increases the volume of money in circulation. Workers go to the market to buy more goods that are mostly in short supply. The pressure on the few goods and services available can lead to significant price increases also known as demand-pull inflation.

4. Infrastructural Development

Ambitious infrastructural projects that governments embark upon are meant to bring development and higher standards of living into the economy. However, unchecked expenditure can lead to excess demand over supply.

Worse still, when corruption and mismanagement creep in, an unbearable increase in prices is likely to occur.

5. Frivolous Government Spending

When much of government expenditure is on areas that waste money rather than stimulate production and growth, demand is most likely going to exceed supply. The result is demand-pull inflation.

6. Overspending During Elections

In many developing countries in Africa and elsewhere, ruling parties are known to overspend at election time. Monies are spent freely on unplanned and unnecessary projects just to win votes in certain constituencies.

Again, it is an open secret that both the ruling and opposition parties put aside huge sums of money for the sole purpose of vote buying.

The resulting excess money supply often marks the beginning of long periods of very high inflation in these countries.

7. Tax Reduction and Exemption Policies

A different fiscal policy initiative that is among the causes of demand-pull inflation is a reduction in income taxes.

A significant decrease in income tax and profit tax rates, for example, puts more money in consumers’ pockets.

This will allow demand to increase while supply remains constant in the short run. The excess demand is likely to cause an increase in the rate of inflation.

8. Rapid Population Growth

It is not only monetary policy or fiscal policy that can lead to demand-pull inflation.

Demand-pull inflation can also result from a very high rate of population growth. The marked increase in the number of people in the country may be caused by a combination of factors such as the following.

• Increasing birth rates and declining death rates
• A rise in net migration is due to several factors. This is when immigration numbers exceed emigration.

Whatever the cause, an increase in population can lead to a rise in demand for goods and services. If the supply of commodities does not keep up with the demand, prices can rise, leading to inflation

The Causes of Cost-Push Inflation

Another type of inflation is cost-push inflation.

Cost-push inflation is when the persistent increase in the general price level is largely a result of increasing costs of production.

When the cost of producing goods and services increases, producers and sellers need to increase the prices of those products in order to at least break even and stay in business.

Thus, it is rising production costs that drive this type of inflation.

Here is a summary of the causes of cost-push inflation.

• A sustained increase in the prices of the major factors of production such as land, labour and capital is behind cost-push inflation.

• Again, government monetary policy may create conditions that result in cost-push inflation.

• An unfavourable fiscal policy regime is another likely source of cost-push inflation in the economy.

• Currency depreciation (or devaluation) is also likely to lead to cost-push inflation.

• Where producers need to import their goods and other inputs from other countries that are themselves going through an inflationary period. such higher costs begin to reflect in the pricing of goods on the local market.

Let’s now take our time to explain, in greater detail, the causes of the kind of inflation which is largely driven by increasing costs of production in the economy.

Monetary Policy and Cost-Push Inflation

The level of interest rates and a policy of currency devaluation can significantly impact the cost of producing goods and services in the economy. This will in turn lead to higher inflation.

9. Higher Lending Rates

An increase in interest rates means higher costs of credit. Such a monetary policy can result in increased costs of production. The next possible effect is a higher inflation rate.

10. Devaluation

Devaluation is when the government deliberately reduces the value of the local currency in relation to major international currencies such as the US dollar.

Devaluation is a monetary policy tool that the central bank may resort to when it wants to deal with issues such as the unfavourable balance of payments.

One key objective of devaluation is to reduce import expenditure by discouraging the demand for imported goods.

It is hoped that in the face of higher import prices where importers now need to pay more in terms of the devalued local currency for the same basket of imported commodities, consumers will shy away from such expensive goods.

This follows the basic law of demand.

Unfortunately, the demand for imported goods, especially in most developing economies, is still very much inelastic.

One reason for this is the shortage in the supply of local substitutes.

Another one is the low quality of some of these locally-produced goods.

So, while a devaluation policy may have brought about higher production costs and higher prices (aka inflation) consumers have no other choice but to continue patronizing those same imported goods.

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Fiscal Policy and Cost-Push Inflation

Certain government expenditures and tax policies are known to be among the major causes of inflation in many countries.

11. Increase in Wages

An increase in the minimum wage, for example, results in higher labour costs.

Private sector employers and producers, for example, have no option other than increase the prices of their goods and services. This is a clear case of inflation being driven by an increase in the cost of labour.

Inflation resulting from this wage-price spiral is often referred to as built-in inflation.

12. Indirect Tax Increases

Increases in Import Duty, Value Added Tax, Excise Duty and other forms of indirect taxation can lead to higher costs of production.

Producers tend to transfer such higher costs onto consumers by way of an increase in the prices of their goods and services.

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Other Causes of Cost-Push Inflation

Certain unfavourable economic conditions that may not be a direct result of any deliberate fiscal or monetary policy can result in cost-push inflation.

In most cases, these causes of inflation are the by-products of general economic mismanagement or international social, political and economic upheavals or both.

Let’s have a look at a few.

13. Energy Price Increases

Most economies rely heavily on energy to keep production and other economic activities going. Examples are oil, gas and electricity.

For that reason, a slight increase in energy prices, for any reason, quickly results in higher prices in almost every other sector of the economy.

14. Increase in the Prices of Raw Materials

Prices of manufactured goods tend to rise significantly any time the cost of procuring raw materials increases.

The same goes for other inputs that are used in the primary and tertiary sectors of the economy.

15. Depreciation of the Local Currency

An unfavourable exchange rate is likely to cause cost-push inflation.

As the value of the local currency falls in relation to major global currencies such as the US dollar and the Euro, prices of imported goods, including raw materials, begin to increase.

Now, importers and producers must find more of the local currency to pay for the same quantity of imported goods that are priced in foreign currency.

Thus, under depreciation, when the local currency is weak, imported goods become more expensive. It is consumers who ultimately bear the brunt of the increasing costs of imports resulting from a depreciating currency.

Other Causes of Inflation

The below additional causes of inflation often result from a blend of demand and cost conditions.

16. Imported Inflation

It is not only depreciation or devaluation of the local currency which can lead to imported inflation. Inflation may also be imported into the country simply by importing finished goods from a country (or countries) that is experiencing a high rate of inflation.

Businesses that import these types of goods may need to increase their wholesale or retail prices to maintain their profit margins.

For example, my friend in Kumasi, Ghana, who sells sandals and slippers imported from China, will have to adjust prices upwards if inflation in China affects any of her imported goods. This can contribute to the inflation situation in Ghana.

17. Speculation and Hoarding

When consumers expect prices to rise in the near future, they may start to hoard goods and speculate on prices. This can create a shortage of goods and drive prices up, leading to inflation.

18. Inflation Expectations

If people expect inflation to occur, they may take certain actions which may lead to actual inflation.

For example, workers may demand higher wages to keep up with expected price increases.

When employers bow to these pressures, it can potentially increase the cost of production which will force them to eventually increase their prices.

This can lead to inflation.

19. Economic Growth

One of the most surprising causes of inflation is economic growth. So how does this happen?

Economic growth can cause inflation if the economy is operating near or at full capacity. As businesses expand, they may need to pay higher wages or purchase more expensive materials, which can increase costs and prices.

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20. Natural Disasters

Natural disasters such as floods, earthquakes or hurricanes can disrupt the supply chain and reduce the production of goods. The shortage can lead to an increase in prices, which can cause inflation.

21. Poor Infrastructure

Poor infrastructure such as bad, inaccessible roads can make it difficult for goods to reach the intended market centres.

The higher costs of transporting goods and the shortage created through delays and spoilage can result in price increases.

22. Unreliable Energy Supply

In developing economies like Ghana and Nigeria, inefficiencies in the supply of energy have caused production costs to increase.

This is because unreliable energy supply brings about a fall in the supply of commodities whose production relies heavily on energy supply. Prices go up as a result.

23. Bad Weather

Most developing countries rely heavily on the weather for agricultural production. Therefore, a single year of crop failure due to a lack of rainfall often results in serious inflation rates for many years to come.

24. World Events

Finally, global events such as wars, political instability, diplomatic tensions and trade restrictions can disrupt the supply chain.

One consequence of such upheavals is an increase in food and other commodity prices.

Conclusion

We have seen that the causes of inflation in a country and the entire world are varied. While some cases of inflation in a given country may be due to internal factors, others are largely caused by external developments on the world stage. The bottom line, however, is that in most cases, it is government monetary and fiscal policies that create the conditions that may lead to demand-pull inflation or cost-push inflation.

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