Causes of high inflation

Discuss the causes of high inflation Inflation is the sustained increase in average general price level when cost of living becomes expensive and value of money decreases. There are 2 factors that cause Inflation, Demand-Pull inflation and Cost-Push inflation. AS1 PL AS PL PLZ PLI AS PL2 PLI AD RO AD Y2 V AD1 1 ¥2 ΒΩ Cost push inflation Demand pull inflation For high inflation, there are only two reasons why it occurs. The first reason is because of demand-pull inflation. This is when aggregate demand shifts to the right causing aggregate demand to be too high, which will result in a rise of the price level at the same time. Demand could be high due to low interest rates. If interest rates are low, then there is less reward for saving and less cost of borrowing. This will most likely mean more money is borrowed from the bank and people will have more money and more disposable income. This will increase consumerism and since consumerism is 60-65% of aggregate demand in the UK the aggregate demand curve will most likely shift right. If this happens then the price level but so does the real output. The rise in price level is inflation and if the economy is at the full capacity stage then the demand curve shifting right will only bring inflation. However, if the economy is at spare capacity then aggregate demand shifting right may not increase price levels since the economy is not at the full employment stage. Therefore, this may not lead to inflation even if AD rises. Moreover, in the long run, if aggregate supply also increases with aggregate demand then it may not lead to inflation. For example, if infrastructure and confidence levels in an economy are high then Investment probably increases. Investment is a component of aggregate demand so the demand curve shifts right. Also, Investment affects aggregate supply. High investment means aggregate supply shifts right. If AD and AS both shift right, then there will be economic growth without inflation. The second factor that causes inflation is cost-push inflation. If aggregate supply shifts left, then price levels will rise and cause inflation. Aggregate supply may shift left due to high cost of production. For example, high value added tax (VAT) can mean cost of production will rise. This means firms make less profit and because they have a profit incentive. Therefore, AS shifts left and it will increase the price level. This shifts aggregate supply to the left and brings inflation. Also inflation can be caused by high NMW. If high NMW it will raise the COP and therefore PL.. Finally, if raw material becomes expensive will mean firms will face high cost of production, leading to the aggregate supply curve shifting left, causing inflation. However, it depends on how much the aggregate supply curve shifts left. If it is a slight shift, there will be disinflation, this is when prices rise but at a slower rate. Disinflation is not as bad as inflation. It also depends on other countries. Also, If economy is producing at a spare capacity may not affect the price level despite AS is shifting to the left. Moreover, demand pull inflation is not as bad as cost push inflation. Cost push inflation increases price levels without increasing output. This can bring inflation and a recession. On the other hand, demand pull inflation may increase price levels but it also increases output. This will bring inflation but it will also bring economic growth. In conclusion, there are some factors which may result in demand pull and cost push inflation at the same time. E.g. high NMW, people will demand more due to high income as well as less AS due to high COP. It will result in hyper-inflation. Also, another example is lower exchange rate, means exports rising but imported raw material is expensive. X rising will raise AD but AS will shift to the left due to high COP hence It will result in hyper-inflation.