Inflation occurs when prices rise and the purchasing power of money declines. It’s a natural part of an economy’s ebb and flow that’s essential to economic growth, allowing people to buy more of the things they want and need with the income they earn. But when inflation becomes too extreme, it can be dangerous. The best way to avoid runaway inflation is by keeping demand and production in balance, which requires a well-functioning labor market and an economy that’s capable of absorbing shocks.
The COVID-19 pandemic created a lot of stress on both, making it difficult to keep prices in check. When lockdowns lifted, consumers began spending more quickly, but many companies struggled to keep up. Their operations were scaled back, and they faced shipping delays, shortages of labor and key production inputs, and a surge in prices for raw materials.
As a result, they were forced to raise prices for their goods and services. This is known as “demand-driven” inflation.
Another factor contributing to rising prices is “cost-push” inflation. If the price of an important production input (like copper) surges, companies that use the material to make their goods will pass those higher costs onto consumers. If they don’t, their profits will take a hit and they risk losing customers to foreign competition that does.
These three types of inflation are all playing a role in the recent surge. But a few other factors have also contributed to the increase, including the repercussions of Russia’s invasion of Ukraine and the shock to energy and food prices that resulted.
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