Why does inflation get so high?

When we read economic reports and follow financial news, recent commentary has expressed concerns about the height of global inflation, and it’s easy to wonder why inflation gets as high as it does.

Inflation is simply when the prices of goods and services in an economy go up over time, which can happen for several reasons.

One reason is that prices will go up if people want to buy more stuff than is available. This is basic supply and demand: if there’s more demand for something than there is supply, the price will go up.

Another reason for inflation is if the cost of production increases. For example, if the cost of the raw materials needed to make a product increases, manufacturers may need to charge more in order to remain profitable.

Central banks can also affect inflation by changing the amount of money in the economy. If a central bank decides to print more money, more money will be floating around for people to use. But, if more money is chasing the same amount of goods and services, prices will go up, which is called monetary inflation.

In addition to these economic factors, things like political instability, government regulations, and geopolitical tensions can also play a role in inflation.

If a country is facing a lot of political uncertainty, people may start hoarding money, which can drive up prices. Or, foreign investors may pull out of local industry due to political influences, making it harder for businesses to make ends meet without driving up their prices.

So as you can see, there’s no single cause of inflation, but rather a combination of factors that can drive up prices. In recent years we’ve seen the following:

Supply chain disruptions: Disruptions in the global supply chain, such as those caused by the COVID-19 pandemic or the war between Russia and Ukraine, led to shortages of goods and drove up prices.
Monetary policy: Expansionary monetary policies, such as low-interest rates and increased money supply, have also led to higher inflation.

Commodity prices: An increase in the prices of raw materials and commodities, such as oil, was a significant contributing factor. The US Bureau of Labour reported that ​​in 2022, prices for unprocessed goods for intermediate demand moved up 11.7%, following a 40% jump in 2021.

Political and geopolitical factors: Political instability, government regulations, and geopolitical tensions can also contribute to inflation. According to the Federal Reserve in the US, global geopolitical risks have soared since Russia invaded Ukraine. Investors, market participants, and policymakers expect that the war will exert a drag on the global economy while pushing up inflation, with a sharp increase in uncertainty and risks of severe adverse outcomes.

All of this is just in recent times, within a few months of writing this blog. Still, it’s important to note that inflation is a complex phenomenon, and the reasons behind high inflation can vary depending on the specific context and country.

A sound financial plan considers the effects of inflation and tries to mitigate the long-term impact. When we plan, it’s never doom and gloom; planning equips us with a positive mindset as well as a coherent strategy to approach both the ups and the downs that inevitably lie ahead.

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