Types of Inflation Explained: Demand-Pull, Cost-Push, and More

Inflation is an economic concept that affects purchasing power, cost of living, and financial stability. Understanding its various forms is essential for individuals, businesses, and policymakers to make informed decisions. Each type arises from different causes and has distinct implications for the economy.

This article explores the major types of inflation, including demand-pull, cost-push, and others, highlighting their unique characteristics and effects.

Demand-Pull

Demand-pull inflation occurs when aggregate demand surpasses aggregate supply, driving up prices. This often results from increased consumer spending, government expenditure, or business investment. For instance, during economic expansion, higher disposable income can prompt greater spending on goods and services, straining production capacities and leading to price hikes.

One example is the inflationary pressures following fiscal stimulus measures, such as during the COVID-19 pandemic. Stimulus packages increased consumer purchasing power, triggering heightened demand and subsequent price increases across various sectors.

Central banks often counteract demand-pull inflation by adjusting monetary policy tools like interest rates. Raising interest rates makes borrowing costlier, discouraging spending and investment, which helps temper demand. Historically, the Federal Reserve has used this approach to address such inflationary trends.

Cost-Push

Cost-push inflation arises from rising production costs, which drive up consumer prices. This can be caused by increases in raw materials, labor, or other inputs. For example, higher oil prices can elevate transportation and manufacturing costs, impacting a wide range of goods.

The oil crises of the 1970s exemplify cost-push inflation, where embargoes led to soaring energy prices and economic disruptions. More recently, supply chain issues and geopolitical tensions have caused fluctuations in commodity prices. A notable case is the semiconductor shortage, which raised costs in the electronics and automotive industries.

In response, businesses may absorb increased costs, reducing profit margins, or pass them onto consumers, potentially curbing demand. Companies might also adopt cost-saving measures like new technologies or supply chain optimizations to mitigate these pressures.

Built-In

Built-in inflation, or wage-price inflation, occurs when rising wages increase production costs, prompting businesses to raise prices. This leads to higher wage demands from workers, creating a cycle. Expectations of future price increases often drive this phenomenon, influencing wage negotiations and pricing strategies.

Labor contracts and collective bargaining agreements frequently tie wage adjustments to inflation indices like the Consumer Price Index (CPI). As the CPI rises, wages follow, perpetuating the inflationary cycle.

Central banks manage built-in inflation through strategies like inflation targeting, aiming to stabilize expectations. If inflation exceeds targets, measures such as interest rate hikes are implemented to curb spending and borrowing, cooling inflationary pressures.

Hyperinflation

Hyperinflation is an extreme form of inflation, with prices rising uncontrollably, often exceeding 50% per month. This typically results from a collapse in a country’s monetary system, often due to excessive money printing without corresponding economic growth. Zimbabwe’s late-2000s crisis illustrates this, with inflation reaching unfathomable levels, rendering its currency worthless and forcing reliance on foreign currencies.

Hyperinflation often stems from fiscal mismanagement, such as financing budget deficits through money printing. In accounting, hyperinflation necessitates specific reporting adjustments. Under International Financial Reporting Standards (IFRS), entities in hyperinflationary economies must prepare financial statements using a measuring unit current at the reporting period’s end. This adjustment mitigates hyperinflation’s distortive effects on financial reporting.

Asset Price Inflation

Asset price inflation refers to sustained increases in the prices of financial and real assets, such as stocks, bonds, real estate, and commodities, beyond what economic fundamentals justify. Unlike consumer price inflation, which affects everyday goods, asset price inflation primarily impacts investors and wealth holders, often exacerbating wealth inequality. It is frequently linked to loose monetary policies, such as prolonged low interest rates or quantitative easing, which inject liquidity into financial markets and elevate asset valuations.

For example, after the 2008 financial crisis, central banks employed aggressive monetary easing to stabilize economies. While effective in avoiding deeper recessions, these policies contributed to significant asset price inflation. Between 2009 and 2021, the S&P 500 index grew at an annual rate far exceeding historical norms, and housing markets in countries like the U.S. and Canada saw double-digit price increases, fueled by low borrowing costs and high demand.

From an accounting perspective, asset price inflation complicates valuation and financial reporting. Under IFRS 13 or ASC 820 (Fair Value Measurement), companies must assess fair asset values, which can become distorted during inflated markets. This can lead to discrepancies between reported values and economic worth, influencing investment decisions and financial stability. Investors often use valuation metrics like price-to-earnings (P/E) ratios to assess whether prices are inflated relative to underlying fundamentals. Elevated ratios may indicate overheated markets, prompting caution among stakeholders.