US & World Economies Economic Theory What Are the Major Causes of Inflation? Cost-push and demand-pull explained By Kimberly Amadeo Updated on September 9, 2022 Reviewed by Erika Rasure Reviewed by Erika Rasure Erika Rasure is globally-recognized as a leading consumer economics subject matter expert, researcher, and educator. She is a financial therapist and transformational coach, with a special interest in helping women learn how to invest. learn about our financial review board Sponsored by What's this? & In This Article View All In This Article Demand-Pull Inflation Factors of Demand-Pull Inflation Cost-Push Inflation Frequently Asked Questions (FAQs) Photo: The Balance / Laura Porter Inflation often feels like a mysterious economic force—one that affects everyone but seems difficult to predict. In reality, however, inflation is a response to a few key factors in the economy. There are two main causes of inflation: demand-pull and cost-push. Both are responsible for a general rise in prices in an economy, but each works differently to put pressure on prices. Demand-pull conditions occur when demand from consumers pulls prices up, while cost-push occurs when supply costs force prices higher. Some sources cite a third cause of inflation: expansion of the money supply. However, the Federal Reserve explains that the relationship of money supply to inflation has decreased over time, and is not a separate cause of its own. Let's look at the two main causes of inflation in depth to gain a deeper understanding of this important and complex economic issue. Key Takeaways There are two major types of inflation: demand-pull and cost-push.Demand-pull inflation occurs when consumers have more money to spend or are otherwise encouraged to purchase products and services.Cost-pull inflation happens when supply decreases and producers raise prices to offset their costs of production. Demand-Pull Inflation Demand-pull inflation is the most common cause of rising prices. It occurs when consumer demand for goods and services increases so much that it outstrips supply. Producers, meanwhile, can't make enough to meet demand and may not have time to build the manufacturing needed to boost supply. They also may not have enough skilled workers to make it, or the raw materials might be scarce. If sellers don't raise the price, they will sell out and eventually come to realize they now have the luxury of hiking up prices. If enough sellers do this, they create inflation. There are several circumstances that create demand-pull inflation. For example, a growing economy affects inflation because when people get better jobs and become more confident, they spend more. As prices rise, people start to expect inflation. That expectation motivates consumers to spend more now to avoid future price increases. That further boosts growth. For this reason, a little inflation is good. Most central banks recognize this. They set an inflation target to manage the public's expectation of inflation. The U.S. central bank, the Federal Reserve, has set a target of 2% as measured by the core inflation rate. The core rate removes the effect of seasonal food and energy cost increases. Another circumstance is discretionary fiscal policy, which is when the government either spends more or taxes less. Putting extra money in people's pockets increases demand and spurs inflation. Factors of Demand-Pull There are a few key factors that can play roles in causing demand-pull inflation, as outlined below. Marketing and New Technology These factors create demand-pull inflation for specific products or asset classes. The asset inflation that results can drive widespread price increases. For example, Apple uses branding to create demand for its products, which allows it to command higher prices than the competition. Asset inflation also helped spark the housing market crisis. New technology had become popular, leading to a rise in the sale of financial derivatives. These new products created a boom-and-bust cycle in the housing market in 2005. As demand for housing was spurred on by a sudden surge in these products, housing construction labor inflated quickly, setting up a crash in construction labor when the asset bubble burst and housing demand plummeted. Expansionary Fiscal Policy Expanding the money supply can also create demand-pull inflation. When the money supply expands, it lowers the value of the dollar. When the dollar declines relative to the value of foreign currencies, the prices of imports rise. That increases prices in the general economy. The money supply can increase through expansionary fiscal policy, which is enacted by the federal government. These policies expand the money supply by pumping money into certain segments of the economy, creating demand-pull inflation in those areas. The government stimulus programs enacted during the COVID-19 pandemic are good examples of expansionary fiscal and monetary policies. As inflation began to rise rapidly in 2021 and 2022, many economists agreed that these expansionary policies, which put a significant amount of cash in Americans' pockets, had played at least a partial role in driving up prices. Note Occasionally, the government can create inflation simply by printing more cash. Venezuela did this between 2013 and 2019, creating hyperinflation, and its money effectively became worthless. Expansionary Monetary Policy The Federal Reserve controls expansionary monetary policy, which is another way to increase the money supply. The Fed expands the money flowing through the economy by creating more credit with the use of its many tools. One tool is lowering the fed funds rate, which is what banks charge each other to borrow funds. This action also lowers all interest rates, which allows borrowers to take out bigger loans for the same cost. When loans become too cheap, too much money chases too few goods and creates inflation. Prices increase across the board, even though neither demand nor supply has changed. It's important to note that changes in fiscal or monetary policy don't automatically cause inflation. Ultimately, demand-pull inflation results from a complex interplay of many factors, and these policies are usually meant to interact with those factors to control inflation. This worked fairly well to keep inflation at bay during the Great Recession but did not work as well in response to COVID-19. This is likely due to the unique cost-push factors at play during the pandemic. Cost-Push Inflation The second cause is cost-push inflation. It only occurs when there is a supply shortage combined with enough demand to allow the producer to raise prices. There are several contributors to inflation on the supply side. For example, global supply chain disruptions, like the one caused by the pandemic in 2020, can lead to cost-push inflation. Note In November 2021, the Consumer Price Index (CPI), which covers gas, food, and rent among other costs, soared 6.8% from the year prior, the highest increase in over 30 years, and continued to rise in 2022. This was due in large part to ongoing supply chain issues. Monopolies can also contribute to cost-push inflation because a monopoly controls the entire supply of a good or service. That's why the Sherman Anti-Trust Act outlawed monopolies in 1890. Natural disasters create temporary cost-push inflation by damaging production facilities. That's what happened to oil refineries after Hurricane Katrina. In general, the depletion of natural resources is a growing cause of cost-push inflation. For example, overfishing has reduced the supply of seafood and driven up prices. Government regulation and taxation can also reduce supplies. For instance, in 2018, U.S. tariffs reduced supplies of imported steel. That created shortages in manufactured parts, with some producers raising prices. In 2008, subsidies to produce corn ethanol reduced the amount of corn available for food. This shortage created food price inflation. When a country lowers its currency's exchange rates, this can also create cost-push inflation in imports. That makes foreign goods more expensive compared to locally produced goods. Some economists point to rising wages as another factor that can cause supply-push inflation. This theory states that as companies feel pressure to raise employee pay, they will usually respond by raising prices to absorb these costs. It's important to note that there isn't strong support for this as a major source of inflationary pressure. Frequently Asked Questions (FAQs) What is inflation? Inflation happens when prices for goods and services that people buy on a regular basis go up. This lowers the value of the dollar and decreases your purchasing power. What is the difference between inflation and deflation? Inflation happens when prices go up, and deflation happens when prices go down. Although prices dropping may sound appealing, this can signal a recession when it persists for too long. How high is inflation? As of June 2022, inflation was at its highest level since November 1981. For the 12-month period from July 2021 through June 2022, prices rose by 9.1%. Was this page helpful? Thanks for your feedback! Tell us why! Other Submit Sources The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy. Board of Governors of the Federal Reserve System. 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Congressional Budget Office. "The Impact of Ethanol Use on Food Prices and Greenhouse-Gas Emissions," Pages 2-12. The World Bank. "Inflation in Emerging and Developing Economies; Evolution, Drivers and Policies," Page 279. Economic Policy Institute. "Wage Growth Has Been Dampening Inflation All Along—and Has Slowed Even More Recently." U.S. Bureau of Labor Statistics. "Consumer Price Index Summary."