Demand-pull inflation is a tenet of Keynesian economics that describes the effects of an imbalance in aggregate supply and demand. When the aggregate demand in an economy strongly outweighs the aggregate supply, prices go up. This is the most common cause of inflation.

Demand pull inflation arises when the aggregate demand becomes more than the aggregate supply in the economy. Cost pull inflation occurs when aggregate demand remains the same but there is a decline in aggregate supply due to external factors that cause rise in price levels.

Demand-pull inflation occurs when aggregate demand within the economy increases. Cost-push inflation occurs when the costs of production are increased (e.g. wages or oil) and the supplier forwards those costs onto consumers. As inflation is a general rise in prices over time, this increases inflation.

Consumers have more discretionary income to spend on goods and services. When that increases faster than supply, it creates inflation. For example, tax breaks for mortgage interest rates increased demand for housing.

The most common cause of cost-push inflation starts with an increase in the cost of production, which may be expected or unexpected. To compensate for the increased cost of production, producers raise the price to the consumer to maintain profit levels while keeping pace with expected demand.

Low inflation contributes towards economic stability – which encourages saving, investment, economic growth, and helps maintain international competitiveness….How to achieve low inflation

• Monetary policy.
• Control money supply.
• Fiscal policy.
• Supply-side policies/productivity growth.
• Low commodity prices.

Low inflation can be a signal of economic problems because it may be associated with weakness in the economy. When unemployment is high or consumer confidence low, people and businesses may be less willing to make investments and spend on consumption, and this lower demand keeps them from bidding up prices.

Therefore, zero inflation would involve large real costs to the American economy. The reason that zero inflation creates such large costs to the economy is that firms are reluctant to cut wages. In both good times and bad, some firms and industries do better than others.

Low inflation is an indication of low growth. A normal period of economic growth would typically give a moderate rate of inflation (2%). If inflation has fallen to 0%, it suggests that there is intense price pressure to encourage spending and the recovery is very fragile.

When Inflation Is Good When the economy is not running at capacity, meaning there is unused labor or resources, inflation theoretically helps increase production. More dollars translates to more spending, which equates to more aggregated demand. More demand, in turn, triggers more production to meet that demand.

Why does the Federal Reserve aim for inflation of 2 percent over the longer run? If inflation expectations fall, interest rates would decline too. In turn, there would be less room to cut interest rates to boost employment during an economic downturn.

Lenders are hurt by unanticipated inflation because the money they get paid back has less purchasing power than the money they loaned out. Borrowers benefit from unanticipated inflation because the money they pay back is worth less than the money they borrowed.

Higher inflation is usually looked on as a negative for stocks because it increases borrowing costs, increases input costs (materials, labor), and reduces standards of living. But probably most importantly in this market, it reduces expectations of earnings growth, putting downward pressure on stock prices.

Here are some of the top ways to hedge against inflation:

• Gold. Gold has often been considered a hedge against inflation.
• Commodities.
• 60/40 Stock/Bond Portfolio.
• Real Estate Investment Trusts (REITs)
• S&P 500.
• Real Estate Income.
• Bloomberg Barclays Aggregate Bond Index.
• Leveraged Loans.

When inflation is on the upswing, income-oriented or high-dividend-paying stock prices generally decline. Stocks overall do seem to be more volatile during highly inflationary periods.

Projected annual inflation rate in the United States from 2010 to 2026*

Inflation raises prices, lowering your purchasing power. It also lowers the values of pensions, savings, and Treasury notes. Assets such as real estate and collectibles usually keep up with inflation. Variable interest rates on loans increase during inflation.

Key Takeaways Inflation, in the basic sense, is a rise in price levels. Inflation is viewed as a positive when it helps boost consumer demand and consumption, driving economic growth. Some believe inflation is meant to keep deflation in check, while others think inflation is a drag on the economy.

If inflation starts to increase too quickly, the Fed can increase interest rates to try to slow things down. That means consumers could see higher interest rates on items such as car loans and credit cards. There’s also the risk that it might wait too long and inflation could get beyond its control.

Inflation is good when it combats the effects of deflation, which is often worse for an economy. When consumers expect prices to rise, they spend now, boosting economic growth. An important aspect of keeping a good inflation rate is managing expectations of future inflation.

Pros and Cons of Inflation

• Deflation is potentially very damaging to the economy and can lead to lower consumer spending and lower growth.
• A moderate inflation rate reduces the real value of debt.
• Moderate rates of inflation allow prices to adjust and goods to attain their real price.