What Causes High Inflation Rate

According to the economists, there are primarily five major reasons of high inflation rate. Two economics theory viz. supply-shock inflation (cost-push inflation) and demand pull theory are often taken into consideration to gauge the inflation. Remember inflation rate should always be in the mind of the person wanting to select portfolio to achieve financial goals.

1) Increased demand but lesser supply
2) Manufacturing cost increases
3) Increased commodity prices
4) Rise in supply of money
5) Decrease in value of currency

Let’s understand each of these reasons of increased inflation in detail which will help you safeguarding your financial future:

1) Increase in demand but lesser supply: Being the major cause of high inflation, it is associated with economic theory called “Demand Pull Theory” which states that demand for goods or services increases but on the other hand supplies diminish. Possible reason for this situation is population. With many people rushing to obtain fewer goods, spike in cost is obvious. Also, when cost of product increase in one country but decrease in other, people would prefer buying from the latter, resulting in production rise of one country and owing to lesser demand, production from other country will reduce considerably.

Example: Company launches 100 smartphones at the cost of INR 25,000 ($500). And according the company’s market research, people’s buying capacity cannot exceed this price. So only 100 smartphones are put for sell. But on the other hand, if 500 people bid for 100 smartphones, cost of smarphone will move up and need of more smartphones production will arise (Demand-Supply theory).

2) Increase in manufacturing cost: This reason can be best understood by cost-push inflation (also called as supply-shock inflation) which states that rise in one of the products’ cost, increases the cost of other associated products. Rise in material cost is directly proportional to the product cost. This spike in material cost can be due to increased employees cost, lesser material supplies due to poor monsoon, natural disasters etc. Other external factors are – currency devalued, monetary policy changes etc. Rise in oil prices is the most common reason for increased production cost. Oil prices has historically been a major cause for high inflation rate.

3) Increased commodity price: There are 5 reasons of rise in commodity prices. First is increased population, leading to the increased demand for commodities. Second reason is fluctuations in currency valu. This leads to rise/fall in the cost from country to country. Third is rise in world’s output, resulting in increased supply. Fourth is natural doubt of further inflation rise, forcing people to buy commodities which results in driving the production & cost upwards. Fifth is poor monsoon.

4) Rise in supply of money: When government prints more currencies the wages of people increase. But this increase in earning power, makes people spend more on high end things. And since the company producing these things, can’t manufacture more number of these; the increased demand will force them to increase the production and also the cost of high end object.

5) Decrease in currency value: Higher the money (currency) in circulation lower is it’s value. And opposite too holds true. i.e. lesser the circulating currency, greater is the value of the currency. This again results in demand from one country to go up whereas in other country demand will go down. This directly causes the currency to lose its value.