Causes of Inflation
The Equation of exchange
Cost Push
Demand Pull
The Quantity Theory of Money
• MV=PQ
• If the money supply (M) increases faster
than the level of output (Q) then prices (P)
will rise.
• A 10% increase in Money Supply will
cause a 4% increase in price level (P) if
output (Q) increases by only 6%.
Cost Push
• When rising price level is caused and
sustained by increases in costs.
• The Aggregate Supply Curve shifts to the
left (inwards) causing PL to increase.
Cost Push
• Cost Push inflation is caused by
• Increases in prices of inputs used in
production process (e.g. wages,oil, power,
rents, government charges such as
indirect taxes, carbon emission levies etc,
compliance costs such as OSH
regulations, permits, licences, road user
charges, etc)
Cost Push
• Reduced worker productivity.
• Reduced levels of technology
• Depreciation in value of NZ Dollar
increases costs of imported raw materials.
• Increase in minimum wage rate.
Cost Push
• Producers pass these increased costs on
to consumers in the form of increased
prices.
Demand Pull
• When aggregate demand exceeds
aggregate supply. If aggregate demand
increases faster than aggregate supply
then price level will increase.
• When the AD curve shifts to the right
(outwards)
• AD = C+I+G+(X-M)
Demand Pull
• Demand Pull inflation is caused by
• Rising household incomes (decreased
direct taxes)
• Increased investment spending by
producers (due to lower interest rates,
increased business confidence).
• Depreciation of exchange rate can cause
demand for exports to rise, increasing
prices in local market.
Demand Pull
• Expansionary Fiscal policy (govt runs
budget deficit)
• Individuals expect inflation.
• Increased demand for NZ products
abroad.
• Increase in govt transfer payments (benefit
payments such as Working for Families).
• Positive net migration (more people come
to NZ than leave)