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Causes of Inflation

Causes of Inflation. The Equation of exchange Cost Push Demand Pull. The Quantity Theory of Money. MV=PQ If the money supply (M) increases faster than the level of output (Q) then prices (P) will rise.

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Causes of Inflation

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  1. Causes of Inflation The Equation of exchange Cost Push Demand Pull

  2. The Quantity Theory of Money • MV=PQ • If the money supply (M) increases faster than the level of output (Q) then prices (P) will rise. • A 10% increase in Money Supply will cause a 4% increase in price level (P) if output (Q) increases by only 6%.

  3. Cost Push • When rising price level is caused and sustained by increases in costs. • The Aggregate Supply Curve shifts to the left (inwards) causing PL to increase.

  4. Cost Push • Cost Push inflation is caused by • Increases in prices of inputs used in production process (e.g. wages,oil, power, rents, government charges such as indirect taxes, carbon emission levies etc, compliance costs such as OSH regulations, permits, licences, road user charges, etc)

  5. Cost Push • Reduced worker productivity. • Reduced levels of technology • Depreciation in value of NZ Dollar increases costs of imported raw materials. • Increase in minimum wage rate.

  6. Cost Push • Producers pass these increased costs on to consumers in the form of increased prices.

  7. Demand Pull • When aggregate demand exceeds aggregate supply. If aggregate demand increases faster than aggregate supply then price level will increase. • When the AD curve shifts to the right (outwards) • AD = C+I+G+(X-M)

  8. Demand Pull • Demand Pull inflation is caused by • Rising household incomes (decreased direct taxes) • Increased investment spending by producers (due to lower interest rates, increased business confidence). • Depreciation of exchange rate can cause demand for exports to rise, increasing prices in local market.

  9. Demand Pull • Expansionary Fiscal policy (govt runs budget deficit) • Individuals expect inflation. • Increased demand for NZ products abroad. • Increase in govt transfer payments (benefit payments such as Working for Families). • Positive net migration (more people come to NZ than leave)

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