Cost-push inflation
There are several possible types of inflation, including demand-pull and cost-push inflation. Inflation is defined as a general rise in the level of prices over a period of time.
Cost-push inflation occurs when an economy experiences a negative cost shock.
Using an AD-AS diagram, the effect of a rise in costs is to shift the aggregate supply curve upwards to the left, causing the price level to rise, and aggregate demand to contract.
Cost-push inflation can arise from many sources, including:
- Increases in wage costs above productivity increases.
- Increases in the prices of commodities, such as oil and grains.
- Increases in farm prices as a result of poor harvests.
- Increases in land rental prices.
- A fall in the exchange rate, which increases the price of all imports.
Cost increases shift the aggregate supply curve to the left, with the price level rising to P1, and real output falling to Y1.
The oil shocks of the 1970s triggered cost-push inflation across most of the developed world. By 1975, annual inflation peaked at just under 25% in the UK, and just under 12% in the US.
Stagflation
Sustained cost shocks can contribute to a situation of recession occurring at the same time as inflation - called stagflation.
Historically, rising oil prices have often been at the centre of periods of stagflation, with the 1970s experiencing both high unemployment and inflation levels.
Following the oil shocks of the mid-1970s, unemployment in the UK, US and Canada, and most other developed economies took off in the late 1970s, peaking (in this cycle) at around 12% for the UK and 8% for the US.
US and UK stagflation in the 1970s
US stagflation
UK stagflation
