Inflation- Cause and effect

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Inflation- Cause and effect

Causes

  • Cut in interest rates (DP) - increases spending higher demand means higher prices
  • Increase in the money supply (DP) - printing more money as with more money in supply prices will increase, could cause hyperinflation (NAZI Germany- depression, basket worth more than the money)
  • Higher wages (DP, CP) - higher wages mean higher costs for firms so they increase prices
  • Devaluation (CP) - Imports become more expensive leading to an increase in inflation
  • Increase in VAT (CP) - leads to higher prices so CPI will increase (CPI-CT ignores temporary tax increases as they are usually one off)
  • Rising house prices - positive wealth effect causes consumer led economic growth causing an increase in demand for goods and services.
  • Inflation expectations - self fore-filling prophecy if it is expected it is likely to happen

Effects

  • Menu costs - Costs of changing prices
  • Wage pressure - workers demand higher wages
  • Less competitive - inflation higher than international competitors
  • Real debt level falls - firms with debt may be better off and deficit could decrease
  • Less confidence to invest
  • Cost push inflation - firms costs rise but consumer demand falls
  • Economic growth - Inflation could be a sign of rising demand

Overall summary

Two types of inflation- Demand Pull (DP) and Cost Push (CP). Both have different causes but the effects are usually the same. Different solutions are needed to target each type how every policies such as Monetary Fiscal and Supply side are usually used.

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