Inflationary Pressures
History, Causes, and Economic Effects

Inflationary Pressures Meaning

Inflationary pressures refers to the excessive demand and supply forces that drive up prices within an economy. This pressure occurs when the demand for goods and services surpasses the supply, or when the production of money exceeds the amount needed to meet industrial output and consumer demand. The primary causes of inflationary pressures are demand-pull and cost-push inflation.

When inflationary pressures are present, it forces the economy to either increase production to meet or exceed customer demand, or face rising prices due to supply shortages. This pressure affects commodity prices, often influenced by factors such as fiscal policies and market forces. Government policies, in particular, play a significant role in creating inflationary pressures.

For example, if the demand for wheat in the United States is 30 million tons but the supply is only 10 million, inflationary pressures arise. Suppliers, constrained by limited resources, struggle to meet the high demand, leading to increased prices. Similarly, when the cost of production factors, like raw materials, rises, it contributes to inflationary pressures, resulting in varying degrees of inflation.

History of Inflationary Pressures

Inflation has been a persistent issue since ancient and medieval times, often caused by the excessive hoarding of metal coins, which led to currency shortages. However, the concept of inflation became more widely recognized in the 18th century. In the mid-20th century, economist John Keynes formalized the inflation theory, asserting that when demand exceeds supply, it creates an inflationary pressure curve.

After World War II, many countries, including Germany, experienced significant inflationary pressures, primarily driven by demand-pull inflation. This phenomenon was especially severe in underdeveloped and developing nations, leading to high inflationary pressures. Zimbabwe, for example, dramatically increased its money supply, resulting in hyperinflation within the country.

Causes of Inflationary Pressures

There are many potential causes of inflation:

• Cost-push inflation
• Demand-pull inflation
• Built-in inflation
• The housing market
• Expansionary monetary and fiscal policy
• Monetary devaluation

Cost-Push Inflation

Cost-push inflation occurs when production costs rise, leading to higher prices for goods and services, even though demand remains unchanged. This type of inflationary pressures is driven by increased costs of raw materials, wages, or other production inputs. As production costs increase, businesses pass these additional costs onto consumers, resulting in higher prices for finished goods.

One common indicator of cost-push inflation is the rise in commodity prices, such as oil and metals, which are essential production inputs. For example, if the price of copper increases, companies that use copper in their products may raise their prices to offset the higher costs. This results in consumers paying more, even if the demand for the products hasn't changed.

Wages also significantly impact production costs and are typically the largest expense for businesses. During periods of economic growth and low unemployment, labor shortages can lead companies to raise wages to attract qualified workers. These higher wages increase production costs, which companies may then pass on to consumers, contributing to cost-push inflation.

Natural disasters can also trigger cost-push inflation. For example, if a hurricane destroys a corn crop, the reduced supply of corn could drive prices higher across the economy, as corn is a key input in many products.

Demand-Pull Inflation

Demand-pull inflation occurs when strong consumer demand drives up prices. This type of inflationary pressure arises when the demand for goods and services increases across the economy, leading to higher prices. While short-term imbalances between supply and demand may not be concerning, sustained demand can lead to widespread price increases.

High consumer confidence, often resulting from low unemployment and rising wages, can lead to increased spending and higher demand for products and services. As demand rises and supply becomes limited, consumers are willing to pay more, resulting in higher prices a classic example of the economic principle of supply and demand.

Companies also contribute to demand-pull inflation, particularly when they produce popular or essential goods. For instance, a company may raise prices simply because consumers are willing to pay more. This is especially true for essential goods like oil and gas, where consumer demand provides companies with the leverage to increase prices.

Built-In Inflation and Rising Wages

Built-in inflation occurs when people expect inflation to continue in the future, leading to a cycle of rising prices and wages. As prices increase, workers may demand higher wages to maintain their standard of living. Businesses, facing higher wage costs, may pass these costs onto consumers, further driving up prices. This wage-price spiral creates ongoing inflationary pressures, with each factor reinforcing the other.

The Housing Market

The housing market is another area where inflationary pressures are evident. When the economy is expanding and homes are in high demand, prices rise. This increased demand also affects related industries, such as construction, where the prices of materials like lumber and steel may increase due to higher demand.

Expansionary Fiscal and Monetary Policy

Expansionary fiscal policy by governments can also lead to inflationary pressures by increasing the discretionary income of businesses and consumers. For example, tax cuts may encourage businesses to invest in capital improvements or hire more employees, while consumers may increase their spending. Government spending on infrastructure projects can also boost demand for goods and services, leading to higher prices.

Similarly, expansionary monetary policy by central banks, such as lowering interest rates, can increase the money supply in the economy. As banks lend more money to businesses and consumers, spending and demand rise, contributing to inflationary pressures.

Monetary Devaluation

Monetarists argue that inflation is caused by an excessive supply of money in the economy—too many dollars chasing too few goods. As the money supply increases, the value of money decreases, reducing its purchasing power and leading to higher prices. This relationship is captured in the quantity theory of money (QTM), which states that the money supply multiplied by the velocity of money equals the total nominal expenditures in the economy. As the money supply grows or the velocity of money increases, prices (P) rise, creating inflationary pressures.

The Impact of Inflationary Pressures on Economy

The primary impact of inflation is the decrease in purchasing power. Although the nominal value of currency remains the same, inflationary pressures cause the same amount of money to buy less over time. This effect is most noticeable in everyday expenses such as groceries, rent, and other transactions, even when wages are adjusted for the cost of living.

In response to rising inflationary pressures, the Federal Reserve often enacts monetary policies that lead to higher federal funds rates. These increased rates have a ripple effect, raising the cost of various forms of lending, including credit card rates, which makes borrowing more expensive. As a result, the combination of higher debt costs and elevated prices during inflationary periods can slow down the economy. Companies may sell fewer products, leading to reduced corporate profits, potential layoffs, and financial pressures on households.

This cycle of events, driven by inflationary pressures, can ultimately lead to a recession. The Federal Reserve faces the challenge of balancing inflation control with maintaining acceptable levels of employment. However, efforts to curb inflation often risk increasing unemployment, as these two factors tend to move in opposite directions. While the outcomes of monetary policy are not guaranteed, the Federal Reserve's actions to counter inflationary pressures frequently carry the risk of triggering a recession.

Monetary Policy to Curb Inflationary Pressures

inflationary pressures can be managed through various measures, with contractionary monetary policy being one of the most common methods. This approach aims to reduce the money supply in the economy by increasing interest rates and lowering bond prices. As a result, consumption decreases, prices fall, and inflation slows down.

Monetary policy is a crucial tool for controlling inflationary pressures, primarily by raising interest rates to reduce demand, slow economic growth, and lower inflation. Another effective method is managing the money supply, as there is a strong correlation between money supply and inflation. Additionally, supply-side policies can enhance productivity and efficiency, which helps put downward pressure on long-term costs.

Fiscal policy, which includes government spending, public borrowing, and taxation, also plays a significant role in controlling inflationary pressures. For instance, higher income taxes can reduce disposable income, curb spending, and alleviate inflationary pressures.

In extreme cases of persistent inflation, the government may implement a strategy known as "Surplus Budgeting Policy," where public spending is reduced while taxes are increased simultaneously. Other monetary measures include credit management by the central bank, demonetizing higher-denomination currencies to combat black money, and issuing new currency to replace old notes in cases of hyperinflation. While these measures can be effective, they may disproportionately impact small depositors.

Conclusion

Inflation can be perceived as both a threat and a necessary aspect of economic growth. While it can be unsettling and harmful for many, it also plays a role in driving economic expansion. A critical aspect of inflation is how the government responds, often by raising interest rates to slow the economy, which in turn increases inflationary pressures and the risk of economic downturns. During inflationary periods, some parties may benefit, while others face heightened risks and challenges.

FAQs

Q.What is the difference between inflationary pressures and gaps?

Although both are pretty very similar, there is a difference between them. The inflationary gaps are the projected GDP (Gross Domestic Product) over the actual. At the same time, the inflation pressures include excess demand or supply over each other. As a result, the prices rise, causing Inflation. While both are macroeconomic concepts, the former speaks about market forces (demand and supply), whereas the latter considers employment and GDP.

Q.What is inflationary pressures performance appraisal?

inflationary pressures performance appraisal is the pressure of equality among the employees in an organization. But, it’s a kind of fear within them for partiality bias.

Q.What is an indicator of inflationary pressures?

Increased demand over supply or excess supply over demand indicates inflationary pressures. For example, if there is a limited supply of food grains within the economy.

Q.How can interest rates help to control inflationary pressures?

Individuals and corporations prefer to demand more loans when interest rates are low. In a fractional reserve banking system, each bank loan increases the money supply. An increasing money supply raises inflation, according to the quantity theory of money. Low-interest rates, therefore, appear to lead to more inflation. The price of holding or lending money is determined by the interest rate. In order to draw depositors, banks pay an interest rate on deposits. Banks also get an interest rate from their deposits for money that is loaned. High-interest rates have the potential to minimize inflation. Although this version of the relationship is very simplistic, it underlines why interest rates and inflation appear to be inversely linked.