Cost-push inflation: what is it?

Financial dynamics can cause various types of inflation, a process that involves a general increase in prices with the cost of living becoming more expensive. In particular, under certain circumstances cost-push inflation can occur, a type of inflation that is closely linked to salary increases. This dynamic involves a number of direct consequences on the cost of goods and services.

Cost-push inflation is a type of inflation that is caused by an increase in salaries and the cost of raw materials, with a corresponding increase in overall costs. When this happens, manufacturers are forced to take on higher expenses, so they must inevitably offload some of these costs on to consumers.

Because demand doesn’t change, a cost-push or cost-pull inflation occurs. Of course, companies can choose whether to increase the prices of their products or not, in fact, within reason, they are able to absorb the increase of production costs. However, this process reduces profit margins and, in some cases, becomes unsustainable for companies.

An example of cost-push inflation happened in 1970 in the oil and gas market when OPEC (Organisation of Petroleum Exporting Countries) increased petrol prices despite there being no increase in demand. This decision caused a large increase in production costs for all companies in other sectors and led to a considerable increase in inflation on a global scale.

There are countless causes of cost-push inflation and they are often interconnected and complex. One of these causes is the monopolies within certain sectors, where the presence of a small number of large companies that share the market without free competition can cause a cost-push inflation. This is what happened in the 70s due to OPEC’s decision, with a small number of countries controlling the global production of petrol.

Another cause is an excessive increase in salaries; this situation occurs when workers have high bargaining power and are able to force significant salary increases. Companies grant these salary increases; however, they pass the costs on to the consumers, causing an increase in consumer prices. In any case, this is not a frequently occurring phenomenon in modern society.

Natural disasters can also cause cost-push inflation, when the scale of the disaster substantially reduces the supply of products on the market. This happened in the United States following Hurricane Katrina and in Japan following the 2011 tsunami. Similar processes are also tied to the unsustainability of certain activities, such as overfishing, which reduces the number of fish available and causes consumer prices to increase.

Cost-push inflation can also be due to exchange rates, for example when the value of a national currency drops too low and importing raw materials and products becomes too expensive. Another cause is government regulations and taxation; these two things can make certain products on the market more expensive due to high tax rates or laws that make manufacturing and importing more complex.

In the event of cost-push inflation, there are a few options that governments can use in order to reduce the increase in costs. For example, the Central Bank can increase interest rates to reduce inflation. This is a complex intervention as it also impacts a country’s GDP and decreases its economic performance. Furthermore, high rates also impact employment, by increasing unemployment in the medium and long term.

The best solution is to reduce manufacturing costs through policies that reduce the cost of raw materials, energy and salaries. The government can reduce taxes that companies pay on their employees’ salaries via specific subsidies or decrease taxes on raw materials and sources of energy. The government can also reduce taxes paid by companies, freeing up important assets that companies can use to make production more efficient.

Cost-push inflation also impacts the financial sector; in fact, it’s a phenomenon that investors must monitor carefully. When it occurs, listed companies reduce their profit margin, so it’s important to protect your share portfolio with assets like gold. Also, it’s important to focus on the most efficient companies that are able to limit production cost increases by using innovative technology, whereas less advanced companies are generally impacted more heavily.

In any case, to protect your money, properly diversifying your investments is essential, by opting for diversified long-term strategies and instruments. For example, Fineco’s regular investment plans allow you to invest diversely in funds and EFTs. This investment is accessible to everyone, with costs starting from just £50 a month.