The world sat up and took notice in 2021 and 2022 as prices rose around the globe at the fastest rate for decades. For the first time since the 1970s, consumers were feeling the pinch of higher prices even though their paychecks were roughly keeping pace. Inflation is a threat to all economies because it steals purchasing power from those who spend the most on goods and services. And it is more damaging to lower-income people, who have less disposable income.
What causes inflation is a complex subject, but economists generally divide it into two categories: Demand-pull inflation and cost-push inflation. In demand-pull inflation, the economic principle of supply and demand holds true: if you have resilient interest in something and the product is scarce, prices rise as people clamor for it. This type of inflation is most often seen with experience-based goods and services like travel, concerts, and dining out, where pent-up demand and stockpiles from lockdowns helped push prices up.
In cost-push inflation, prices increase because production costs are going up. This can happen for a number of reasons, such as higher wages, commodity prices, or the price of raw materials. Companies respond by raising prices and the effects of this type of inflation are felt most directly by workers and households.
Neither type of inflation is necessarily bad, but it can become dangerous if it’s not kept in check. That’s why the Fed aims to manage the speed of price changes, rather than the actual levels of inflation, through its monetary policy.
