Theoretical Causes of Inflation
What causes inflation?
There are four economical theories behind the causes of inflation. To inflate in English is to fill (something) with air or gas to make it swell. So the inflation can be naively explained by filling the economy with more money so the price levels of goods and services swell. Actually this is one of the four economic theories behind the causes of inflation. This is mainly caused by governments. When governments want to print more money, then inflation happens. There are many reasons why the governments have to print more money. I like call this cause as the institutional cause. The institutions involved in this are mainly the federal government and the Federal Reserve System.
Inflation can be caused by increases of aggregated demands. When there are more demands of goods and services, the price levels increase. This is known as the demand-pull inflation. When people want to consume more than the firms can produce, the firm can charge higher prices for their goods and services.
Another cause of inflation is decreases of aggregated supply. When the supplies of goods and services decrease, the price levels increase. This is known as the supply-push inflation. When firms reduce its contents per unit of goods and services, the unit prices of goods and services is increased. So the inflation happens.
The demand-pull and supply-push inflations are the results of imbalance between the firms and consumers. So the two causes can be summed up as the production-consumption imbalance inflation. I call this cause as the structural cause since the two pillars of the economy – firms and consumer are not exactly balanced structurally.
Inflation can be influenced by people’s expectation of inflation. This works as the self-fulfilling prophecy. Higher inflation expectation can actually cause higher inflation. Since people’s expectation of inflation can not happen all the time. Let’s assume people expect higher inflation 50% of the time. Then this cause of inflation works 50% of time. I consider this cause as the psychological cause.
In summary, there are mainly three causes of inflation – institutional, structural, and psychological factors. Historical inflation data suggests that the inflation rate is approximately 2.5% annually. I would like to attribute 1% each of each factor. Since the psychological factor only works 50% of the time. So the long-term average inflation caused by psychological factor is only 50 basis points.
An inflation rate of 2.5% annually might be a good theoretical number for the economy. In my previous blog I suggested that the inflation rate, real interest rate, and productivity are equal to each other. Then the theoretical nominal interest rate should be 5% when the productivity rate is 2.5%. This is approximately a reflection of the current US economy.
There are four economical theories behind the causes of inflation. To inflate in English is to fill (something) with air or gas to make it swell. So the inflation can be naively explained by filling the economy with more money so the price levels of goods and services swell. Actually this is one of the four economic theories behind the causes of inflation. This is mainly caused by governments. When governments want to print more money, then inflation happens. There are many reasons why the governments have to print more money. I like call this cause as the institutional cause. The institutions involved in this are mainly the federal government and the Federal Reserve System.
Inflation can be caused by increases of aggregated demands. When there are more demands of goods and services, the price levels increase. This is known as the demand-pull inflation. When people want to consume more than the firms can produce, the firm can charge higher prices for their goods and services.
Another cause of inflation is decreases of aggregated supply. When the supplies of goods and services decrease, the price levels increase. This is known as the supply-push inflation. When firms reduce its contents per unit of goods and services, the unit prices of goods and services is increased. So the inflation happens.
The demand-pull and supply-push inflations are the results of imbalance between the firms and consumers. So the two causes can be summed up as the production-consumption imbalance inflation. I call this cause as the structural cause since the two pillars of the economy – firms and consumer are not exactly balanced structurally.
Inflation can be influenced by people’s expectation of inflation. This works as the self-fulfilling prophecy. Higher inflation expectation can actually cause higher inflation. Since people’s expectation of inflation can not happen all the time. Let’s assume people expect higher inflation 50% of the time. Then this cause of inflation works 50% of time. I consider this cause as the psychological cause.
In summary, there are mainly three causes of inflation – institutional, structural, and psychological factors. Historical inflation data suggests that the inflation rate is approximately 2.5% annually. I would like to attribute 1% each of each factor. Since the psychological factor only works 50% of the time. So the long-term average inflation caused by psychological factor is only 50 basis points.
An inflation rate of 2.5% annually might be a good theoretical number for the economy. In my previous blog I suggested that the inflation rate, real interest rate, and productivity are equal to each other. Then the theoretical nominal interest rate should be 5% when the productivity rate is 2.5%. This is approximately a reflection of the current US economy.
posted by Unknown at 8:24 PM
0 Comments:
Post a Comment
<< Home