Demand-pull inflation
Demand-pull inflation is asserted to arise when aggregate demand in an economy outpaces
aggregate supply. It involves inflation rising as real gross domestic product
rises and unemployment falls, as the economy moves along the Phillips curve.
This is commonly described as "too much money chasing too few goods".
More accurately, it should be described as involving "too much money spent
chasing too few goods", since only money that is spent on goods and
services can cause inflation. This would not be expected to persist over time
due to increases in supply, unless the economy is already at a full employment
level.
The
term demand-pull inflation is mostly associated with Keynesian economics.
Demand-pull inflation
is in contrast
with cost-push inflation,
when price and
wage increases are
being transmitted from one sector to another. However, these can be
considered as different aspects of an overall inflationary process: demand-pull
inflation explains how price inflation starts, and cost-push inflation
demonstrates why inflation once begun is so difficult to stop.
Cost-Push Inflation
Cost-push
inflation is a type of inflation caused by substantial increases in the cost of
important goods or services where no suitable alternative is available. A
situation that has been often cited of this was the oil crisis of the 1970s,
which some economists see as a major cause of the inflation experienced in the
Western world in that decade. It is argued that this inflation resulted from
increases in the cost of petroleum imposed by the member states of OPEC. Since
petroleum is so important to industrialized economies, a large increase in its
price can lead to the increase in the price of most products, raising the
inflation rate. This can raise the normal or built-in inflation rate,
reflecting adaptive expectations and the price/wage spiral, so that a supply
shock can have persistent effects.
Monetarist
economists such as Milton Friedman argue against the concept of cost-push inflation
because increases in the cost of goods and services do not lead to inflation
without the government and its central bank cooperating in increasing the money
supply. The argument is that if the money supply is constant, increases in the
cost of a good or service will decrease the money available for other goods and
services, and therefore the price of some those goods will fall and offset the
rise in price of those goods whose prices have increased. One consequence of
this is that monetarist economists do not believe that the rise in the cost of
oil was a direct cause of the inflation of the 1970s. They argue that although
the price of oil went back down in the 1980s, there was no corresponding
deflation