Everything about Cost-push Inflation totally explained
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 industrialized 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.
Austrian school economists such as
Murray N. Rothbard and
monetary economists such as
Milton Friedman argue against the concept of cost-push inflation because increases in the cost of goods and services don't 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 don't 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.
Keynesians argue that in a modern industrial economy, many prices are
sticky downward or
downward inflexible, so that instead of prices falling in this story, a supply shock would cause a
recession, for example, 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.
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