The global price of goods and services has been increasing at an unprecedented rate over the past few years, with inflation rising to almost five percent in most countries worldwide. The rise in prices is fueled by many factors, including increased demand for products and services from consumers, government intervention (including tax increases); speculation on financial markets; currency fluctuations; and a range of other influences. Although this is just another part of life, rising inflation can seriously affect individuals, companies, governments, and investors. This article will explore seven key reasons why inflation is on the increase. Understanding how it works and what you can do about it could be very helpful.
1. Demand
Demand drives economic activity. When there’s more demand than supply, prices tend to go up, leading to more spending and investment. For example, if more people buy cars, car production will increase and, thus, prices. This is one reason some economists believe that inflation always leads to recession. Rising levels of unemployment tend to put downward pressure on wage rates and reduce the purchasing power of those employed. Therefore, prices typically fall when employment grows, and wages rise as employers compete for workers. However, during high unemployment or low growth periods, demand doesn’t usually grow fast enough to outpace supply, resulting in lower prices.
2. Government Intervention- Higher Taxes, Fewer Regulations
Many politicians think they can make inflation worse by increasing taxes, cutting back on regulation, or instituting austerity measures. These policies directly affect the money supply. When the government raises taxes, it reduces the amount of money available in the economy. Businesses will need to charge higher prices to maintain their profit margins. Similarly, reduced regulatory requirements mean that companies won’t be able to afford to pay employees adequately. Finally, when government cuts spending, it causes a reduction in aggregate demand. This results in slower economic growth and, thus, less spending, making firms raise prices to cover costs. All these things together result in higher inflation.
3. Currency Fluctuations
Currency exchange rates can influence inflation because they provide information about the relative strength of different currencies. If a country’s currency falls against others in the market, its citizens might feel wealthier and spend more. Conversely, if a country’s currency rises against foreign ones, its people might not want to buy imports, leading to lower domestic demand. Because of these effects, central banks often try to manage currency values through interest-rate adjustments or direct interventions in the open foreign exchange market.
4. Rising Energy and Petrol Prices
International commodity markets set energy prices. They are affected by geopolitical issues and supply and demand. Oil, gas, coal, and electricity account for about 70% of the average household’s total energy bill. Energy prices affect overall inflation because households must use more resources to fuel their homes and transport themselves. As oil prices rise, the cost of transportation-related – such as travel and heating – also increases.
5. Climate Change
Climate change affects the price of many products that rely on natural resources used for farming and forestry. Crops like wheat, corn, and soybeans require large amounts of water from rivers which may become increasingly scarce as climate change takes hold. Other food commodities, such as milk and eggs, have been found to contain smaller quantities of vitamin D due to changes in the length of the daylight hours caused by seasonal variations in temperature. This has led to claims that global warming could cause widespread deficiencies in these vitamins. Prices of dairy products are already expected to rise significantly. Meat and seafood prices are likely to follow suit.
6. Trade Barriers
Some governments impose tariff (tax) rates that increase product costs. When this happens, consumers must choose between paying the tax or buying cheaper alternatives offered abroad. Tariffs are one of the biggest drivers of inflation. A 2017 study estimated that tariffs were responsible for an additional $367 billion annually of inflation worldwide. The report concluded that “the removal of trade protection would lead to substantial and rapid declines in both world output and inflation.”
7. Rising Wages
Wage inflation occurs when employers pass along the added production costs to customers. The opposite effect can happen when wages fall, as happened during the 2007–2008 financial crisis when some workers accepted wage cuts instead of layoffs. Either way, wage increases drive up the price index. But there’s no obvious relationship between unemployment levels and wage growth; some economists believe that periods of high joblessness don’t produce significant wage pressure. Overall, though, higher wages tend to boost inflation, at least over the short term.
8. Lapse of Covid-19 Support
The end of pandemic support will reduce consumer spending, adding deflationary pressures in economies with low-capacity utilization. For example, a US government stimulus package was announced in mid-March 2020, with an initial sum of $1 trillion intended to help mitigate the economic fallout from the coronavirus outbreak. The plan included increased personal income taxes, expanded access to unemployment benefits, and direct cash payments to most American families. These measures have expired, but the impact may continue to be felt into 2021 and beyond. As a result, the Federal Reserve has cut interest rates twice since March 14th and plans further reductions, including a reduction in the target range for the federal funds rate.
9. Political Instability
Political instability raises uncertainty about future policy decisions, resulting in higher borrowing costs. Consider, for instance, the turmoil surrounding Brexit in the UK, where Prime Minister Boris Johnson suspended Parliament on October 7th, 2019, just six days after Britain voted to leave the EU. The subsequent political impasse resulted in months of delay costing the British economy billions of dollars—and contributed to the decline of sterling against other major currencies. Another recent example of political instability came last November’s US election when Donald Trump was elected president despite losing the popular vote by two million. His victory prompted fears about the stability of the United States democratic system, and it also raised concerns among investors that his administration might pursue policies that could hurt growth.
Accordingly, many experts agree that inflation will likely persist in the coming years. They point to factors fuel continuing inflation, such as high debt levels, fiscal deficits, a weak recovery, and continued monetary easing. However, some argue that the risks associated with high inflation remain manageable. In particular, they point out that any potential rise in inflation should not come as a surprise, given how much central banks have already done to stimulate the economy.
