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Cost-push inflation - Wikipedia, the free encyclopedia

http://en.wikipedia.org/wiki/Cost-push_inflation

Cost-push inflation
From Wikipedia, the free encyclopedia

Cost-push inflation is a type of inflation caused by substantial increases in the cost of important goods or services where no suitable alternative is available. A situation that has been often cited of this was the oil crisis of the 1970s, which some economists see as a major cause of the inflation experienced in the Western world in that decade. It is argued that this inflation resulted from increases in the cost of petroleum imposed by the member states of OPEC. Since petroleum is so important to industrialised economies, a large increase in its price can lead to the increase in the price of most products, raising the inflation rate. This can raise the normal or built-in inflation rate, reflecting adaptive expectations and the price/wage spiral, so that a supply shock can have persistent effects.

Aggregate supply aggregate demand model illustration of aggregate supply (AS) shifting to AS' and causing price level to increase while output shrinks

Keynesians argue that in a modern industrial economy, many prices are sticky downward or downward inflexible, so that instead of prices for non-oilrelated goods falling in this story, a supply shock would cause a recession, i.e., rising unemployment and falling gross domestic product. It is the costs of such a recession that likely causes governments and central banks to allow a supply shock to result in inflation. They also note that though there was no deflation in the 1980s, there was a definite fall in the inflation rate during this period. Actual deflation was prevented because supply shocks are not the only cause of inflation; in terms of the modern triangle model of inflation, supply-driven deflation was counteracted by demand-pull inflation and built-in inflation resulting from adaptive expectations and the price/wage spiral. Monetarist economists such as Milton Friedman argue against the concept of cost-push inflation because increases in the cost of goods and services do not lead to inflation without the government and its central bank cooperating in increasing the money supply. The argument is that if the money supply is constant, increases in the cost of a good or service will decrease the money available for other goods and services, and therefore the price of some those goods will fall and offset the rise in price of those goods whose prices have increased. One consequence of this is that monetarist economists do not believe that the rise in the cost of oil was a direct cause of the inflation of the 1970s. They argue that although the price of oil went back down in the 1980s, there was no corresponding deflation. Modern monetary theorists would add that the central bank and government are not the only sources of money. Lending by banks also constitutes change in the endogenous money supply and risk of inflation / deflation. Thus interest rate policy by the central bank plays a key regulatory role, as noted above, in perhaps accommodating severe cost shocks with (inflationary) anti-recession policies. The government may directly raise net fiscal or tax spending in response to such a shock, also with (demand-pull) inflationary potential, if it rises beyond the relevant sectoral balances (private spending/saving, and the trade balance).

See also
Stagflation

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6/06/2012 1:27 PM

Cost-push inflation - Wikipedia, the free encyclopedia

http://en.wikipedia.org/wiki/Cost-push_inflation

In simpler terms, this is caused when cost of production rise and cause the price level to rise. Retrieved from "http://en.wikipedia.org/w/index.php?title=Cost-push_inflation&oldid=487054231" Categories: Inflation This page was last modified on 12 April 2012 at 19:23. Text is available under the Creative Commons Attribution-ShareAlike License; additional terms may apply. See Terms of use for details. Wikipedia is a registered trademark of the Wikimedia Foundation, Inc., a non-profit organization.

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6/06/2012 1:27 PM

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