What Drives InflationAn increase in the supply of money is the root of inflation. A country's money supply can be increased by the monetary authorities by:
- Printing and giving away more money to citizens- Legally devaluing (reducing the value of) the legal tender currency- Loaning new money into existence as reserve account credits through the banking system by purchasing government bonds from banks on the secondary market (the most common method)In all of these cases, the money ends up losing its purchasing power. High inflation can occur as the result of a variety of factors. However, economists often divide the root causes into two categories: demand-pull inflation and cost-push inflation.
Demand-Pull InflationDemand-pull inflation refers to situations where there are not enough products or services being produced to keep up with demand, causing their prices to increase.
For example, the prices of eggs in 2022 and 2023 were significantly higher than in previous years, and the quantity of cartons available on your supermarket shelves might be limited. This is a result of a drastic decline in the supply of eggs following the most severe outbreak of avian influenza in the United States in 2022.
Cost-Push InflationCost-push inflation, on the other hand, occurs when the cost of producing products and services rises, forcing businesses to raise their prices.
For example, the war between Ukraine and Russia has resulted in an urgent shortage of energy. As oil producers find it challenging to immediately increase output, this has led to a surge in oil prices, causing production costs to rise across various industries. As businesses face increased expenses, they may pass these costs on to consumers in the form of higher prices for goods and services.
It's also possible for inflation to result from factors unrelated to the economy. Natural disasters or major world events can disrupt supply chains and reduce the amount of goods available, driving up prices on the stock that remains. It's also possible for a combination of these factors to occur simultaneously or for one to occur as the result of another.
Key Indicators for Measuring InflationTo assess if inflation is too high, too low or on track, American economists and policymakers typically rely on several indexes that are updated monthly: the consumer price index (CPI), the producer price index (PPI) and the personal consumption expenditures price index (PCEPI).
CPIThe CPI is the most commonly used inflation metric. It’s measured using data gathered monthly by the U.S. Bureau of Labor Statistics, which tracks price changes across a basket of about 80,000 everyday consumer goods and services ranging from groceries to gasoline to health care and utilities.
PPIThe PPI measures inflation from the perspective of the seller. It tracks monthly changes in more than 100,000 prices from about 25,000 establishments that voluntarily report data to the BLS. The PPI is the counterpoint to the CPI, allowing economists to compare price changes for consumers versus sellers.
PCEPIThe PCEPI is used by the Bureau of Economic Analysis to measure the relationship between changing consumer prices and changes in personal income. This is similar to the CPI but not the same. Although the PCEPI also tracks price changes across thousands of goods and services, it also compares those prices to how consumer spending behavior changes.
The PCEPI is often used to help forecast economic trends, and the Fed frequently uses it when creating monetary policy.