After decades of carefully controlled, low inflation that provided economies a measure of stability, global prices rose rapidly during and after the COVID-19 pandemic. This surge, which economists call “inflation,” has raised many questions about its causes. Is it the result of firms raising prices, central banks enacting policy, or a de-anchoring of household inflation expectations? The answer is likely to be a bit of all the above.
Inflation occurs when a country’s economy experiences higher aggregate demand than its supply of goods and services. This higher demand can be driven by several factors, including a rise in the number of people looking for work (leading to higher unemployment), or a sudden increase in production costs (such as from the impact of natural disasters on food supply chains). In either case, the end result is that consumers’ purchasing power decreases. The decline in spending is particularly harmful to lower-income households, who may not have sufficient savings to absorb these changes in their purchasing power.
Meanwhile, businesses that are unable to pass on their increased production costs to consumers through higher prices risk losing customers to foreign competitors unaffected by these increases. This can hurt companies, and their profits. It also reduces the amount of money in circulation, which makes it harder for monetary authorities to control inflation. For this reason, policymakers will want to be careful not to let the surge in inflation lead them to enact looser fiscal and monetary policies that would harm their economy.