Lesson 3
Inflation Causes
Always identify the CAUSE of inflation before predicting the cure. Pure demand-pull: Fed can fix it. Pure cost-push: Fed hikes hurt growth without fixing inflation. Mixed: Look for supply normalization as the key variable.
Inflation has different causes, and the cause determines the cure.
Demand-Pull Inflation:
'Too much money chasing too few goods.'
Causes:
- Excessive monetary expansion
- Fiscal stimulus putting cash in consumers' hands
- Credit boom expanding spending power
Characteristics:
- Economy overheating, low unemployment
- Broad-based price increases
Cure: Fed can fix this by hiking rates.
Cost-Push Inflation:
Supply-side shocks raising production costs.
Causes:
- Energy price spikes
- Supply chain disruptions
- Commodity shortages
Characteristics:
- Economy may be weakening (stagflation possible)
- Inflation concentrated in specific sectors
The Problem: Fed rate hikes don't fix supply problems. Hiking rates into cost-push inflation just slows the economy without fixing the underlying issue. This creates stagflation risk.
The 2021-2022 Mix:
Post-COVID inflation was BOTH:
- Demand-pull: Stimulus checks, easy credit
- Cost-push: Supply chains broken, energy crisis
Inflation fell partly because supply chains normalized, not just because the Fed hiked.
Check your understanding
Lesson Quiz
Quiz Check
Inflation is 8% due to an oil price spike from war, not excess demand. The Fed raises rates aggressively. What's the likely outcome?