How many types of inflation are there

Demand-pull inflation occurs when aggregate demand for goods and services in an economy rises more rapidly than an economy's productive capacity. One potential shock to aggregate demand might come from a central bank that rapidly increases the supply of money.

See Chart 1 for an illustration of what will likely happen as a result of this shock. The increase in money in the economy will increase demand for goods and services from D0 to D1. In the short run, businesses cannot significantly increase production and supply S remains constant. The economy's equilibrium moves from point A to point B and prices will tend to rise, resulting in inflation. Cost-push inflation, on the other hand, occurs when prices of production process inputs increase.

Rapid wage increases or rising raw material prices are common causes of this type of inflation. The sharp rise in the price of imported oil during the s provides a typical example of cost-push inflation illustrated in Chart 2.

Rising energy prices caused the cost of producing and transporting goods to rise. Higher production costs led to a decrease in aggregate supply from S0 to S1 and an increase in the overall price level because the equilibrium point moved from point Z to point Y. While the differences in inflation noted above may seem simple, the cause of price level changes observed in the real economy are often much more complex.

Kimberly Amadeo is an expert on U. She is the President of the economic website World Money Watch. As a writer for The Balance, Kimberly provides insight on the state of the present-day economy, as well as past events that have had a lasting impact. Inflation is when the prices of goods and services increase. There are four main types of inflation, categorized by their speed. They are creeping, walking, galloping, and hyperinflation.

There are specific types of asset inflation and also wage inflation. Some experts say demand-pull and cost-push inflation are two more types, but they are causes of inflation. So is the expansion of the money supply. This kind of mild inflation makes consumers expect that prices will keep going up. That boosts demand. Consumers buy now to beat higher future prices.

That's how mild inflation drives economic expansion. It is harmful to the economy because it heats-up economic growth too fast. People start to buy more than they need to avoid tomorrow's much higher prices. This increased buying drives demand even further so that suppliers can't keep up. More important, neither can wages. As a result, common goods and services are priced out of the reach of most people. Money loses value so fast that business and employee income can't keep up with costs and prices.

Foreign investors avoid the country, depriving it of needed capital. The economy becomes unstable, and government leaders lose credibility. Galloping inflation must be prevented at all costs. It is very rare. In fact, most examples of hyperinflation occur when governments print money to pay for wars.

Examples of hyperinflation include Germany in the s, Zimbabwe in the s, and Venezuela in the s. Stagflation is when economic growth is stagnant, but there still is price inflation. Why would prices go up when there isn't enough demand to stoke economic growth?

It happened in the s when the United States abandoned the gold standard. Once the dollar's value was no longer tied to gold, it plummeted. At the same time, the price of gold skyrocketed.

Stagflation didn't end until Federal Reserve Chairman Paul Volcker raised the fed funds rate to the double-digits. He kept it there long enough to dispel expectations of further inflation. For example, individuals with tangible assets that are priced in currency, like property or stocked commodities, may like to see some inflation as that raises the price of their assets, which they can sell at a higher rate.

However, the buyers of such assets may not be happy with inflation, as they will be required to shell out more money.

Inflation-indexed bonds are another popular option for investors to profit from inflation. On the other hand, people holding assets denominated in currency, such as cash or bonds, may also not like inflation, as it erodes the real value of their holdings.

Investors looking to protect their portfolios from inflation should consider inflation-hedged asset classes, such as gold, commodities, and real estate investment trusts REITs. Inflation promotes speculation, both by businesses in risky projects and by individuals in stocks of companies, as they expect better returns than inflation.

An optimum level of inflation is often promoted to encourage spending to a certain extent instead of saving. If the purchasing power of money falls over time, then there may be a greater incentive to spend now instead of saving and spending later. It may increase spending, which may boost economic activities in a country. A balanced approach is thought to keep the inflation value in an optimum and desirable range.

High and variable rates of inflation can impose major costs on an economy. Businesses, workers, and consumers must all account for the effects of generally rising prices in their buying, selling, and planning decisions. This introduces an additional source of uncertainty into the economy, because they may guess wrong about the rate of future inflation.

Time and resources expended on researching, estimating, and adjusting economic behavior are expected to rise to the general level of prices, rather than real economic fundamentals, which inevitably represents a cost to the economy as a whole.

Even a low, stable, and easily predictable rate of inflation, which some consider otherwise optimal, may lead to serious problems in the economy, because of how, where, and when the new money enters the economy. Whenever new money and credit enters the economy it is always into the hands of specific individuals or business firms, and the process of price level adjustment to the new money supply proceeds as they then spend the new money and it circulates from hand to hand and account to account through the economy.

Along the way, it drives up some prices first and later drives up other prices. This sequential change in purchasing power and prices known as the Cantillon effect means that the process of inflation not only increases the general price level over time, but it also distorts relative prices , wages, and rates of return along the way. Economists, in general, understand that distortions of relative prices away from their economic equilibrium are not good for the economy, and Austrian economists even believe this process to be a major driver of cycles of recession in the economy.

It is done by implementing measures through monetary policy , which refers to the actions of a central bank or other committees that determine the size and rate of growth of the money supply. The Federal Reserve clearly communicates long-term inflation goals in order to keep a steady long-term rate of inflation, which is thought to be beneficial to the economy. Price stability—or a relatively constant level of inflation—allows businesses to plan for the future since they know what to expect.

The Fed believes that this will promote maximum employment, which is determined by non-monetary factors that fluctuate over time and are therefore subject to change. For this reason, the Fed doesn't set a specific goal for maximum employment, and it is largely determined by employers' assessments. Maximum employment does not mean zero unemployment, as at any given time there is a certain level of volatility as people vacate and start new jobs.

Monetary authorities also take exceptional measures in extreme conditions of the economy. For instance, following the financial crisis, the U. Fed has kept the interest rates near zero and pursued a bond-buying program called quantitative easing. Some critics of the program alleged it would cause a spike in inflation in the U.

There are many complex reasons why QE didn't lead to inflation or hyperinflation , though the simplest explanation is that the recession itself was a very prominent deflationary environment, and quantitative easing supported its effects. Consequently, the U. The European Central Bank has also pursued aggressive quantitative easing to counter deflation in the eurozone, and some places have experienced negative interest rates , due to fears that deflation could take hold in the eurozone and lead to economic stagnation.

Moreover, countries that are experiencing higher rates of growth can absorb higher rates of inflation. Stocks are considered to be the best hedge against inflation, as the rise in stock prices is inclusive of the effects of inflation.

Since additions to the money supply in virtually all modern economies occur as bank credit injections through the financial system, much of the immediate effect on prices happens in financial assets that are priced in currency, such as stocks. Additionally, special financial instruments exist which one can use to safeguard investments against inflation. They include Treasury Inflation-Protected Securities TIPS , low-risk treasury security that is indexed to inflation where the principal amount invested is increased by the percentage of inflation.

To get access to stocks, ETFs, and other funds that can help to avoid the dangers of inflation, you'll likely need a brokerage account. Choosing a stockbroker can be a tedious process due to the variety among them. Gold is also considered to be a hedge against inflation, although this doesn't always appear to be the case looking backward.

Since all world currencies are fiat money , the money supply could increase rapidly for political reasons, resulting in rapid price level increases. The most famous example is the hyperinflation that struck the German Weimar Republic in the early s.

The nations that had been victorious in World War I demanded reparations from Germany, which could not be paid in German paper currency, as this was of suspect value due to government borrowing. Germany attempted to print paper notes, buy foreign currency with them, and use that to pay their debts. This policy led to the rapid devaluation of the German mark , and hyperinflation accompanied the development. German consumers responded to the cycle by trying to spend their money as fast as possible, understanding that it would be worth less and less the longer they waited.

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