Causes of Inflation

The causes of inflation are usually grouped on the demand side and the supply (cost) side, mirroring the demand-pull/cost-push distinction from the previous section.

Demand-side causes (demand-pull):

• Increase in money supply — when the RBI or the banking system expands credit/currency faster than the growth of output, more money chases the same quantity of goods.
• Rising government expenditure financed by deficit financing (borrowing from the RBI, effectively creating new money) — common during wars, large public projects or subsidy programmes.
• Rising exports — a surge in exports withdraws goods from the domestic market while the export earnings add to domestic purchasing power, pushing up domestic prices of the goods still available.
• Population growth — a growing population steadily raises aggregate demand for goods and services, especially if production does not expand at the same pace.
• Tax cuts — lower direct taxes leave households with more disposable income to spend, raising demand.
• Cheap/easy monetary policy — low interest rates encourage both consumers and businesses to borrow and spend more.

Supply-side causes (cost-push):

• Rising wages — a wage increase not matched by a rise in productivity raises the per-unit cost of production, which is then passed on as higher prices (a 'wage-price spiral' if the cycle repeats).
• Rising cost of raw materials and imported inputs — e.g. a spike in international crude oil prices raises transport and production costs economy-wide.
• Increase in indirect taxes — a higher GST or excise duty is generally passed on to the final consumer as a higher price.
• Natural calamities and crop failures — floods, droughts or pest attacks reduce the supply of agricultural goods, pushing up their prices.
• Hoarding and black-marketing — artificially restricting supply to profit from a future price rise pushes current prices up.
• Infrastructural bottlenecks — inadequate power, transport or logistics capacity restricts how fast supply can respond to demand, allowing prices to rise instead. …