Factors Affecting Inflation Rate

Inflation is defined as a rise in an economy’s general price level across a variety of sectors, including
housing, energy and food. Historically, the U.S. inflation rate has averaged 3 percent annually. From
1917 to 1920, in 1942, and in the late 1970s, however, it rose above 10 percent. Russia and some Latin
American countries are among those with historically high inflation rates. A negative inflation rate is
called deflation.

Money Supply

Central banks can control interest rates by increasing or decreasing the money supply. Increasing the
amount of currency in circulation causes interest rates to fall. When the growth of the money supply
outpaces the growth in the economy, however, inflation rises. Since the major currencies moved away
from the gold standard in the last century, the value of a currency is a function of its supply and demand
in the global market. Increasing the supply of a currency faster than the country’s economy floods the
market with supply that decreases its relative value. Inflation is the result of this devaluation.

National Debt

Over the long run, continually increasing a country's national debt will lead to increasing inflation. Any
strategy a country takes to combat a rising national debt can ultimately lead to higher inflation. The first
strategy for decreasing the national debt is to increase tax revenue. Corporations must earn money for
shareholders, so they are likely to respond to higher tax rates by raising prices on their goods and
services. Higher priced goods and services result in higher inflation. The second strategy for decreasing
the national debt is to increase the money supply, using this money to pay off the existing debt, but this
can also lead to inflation as the higher supply of money makes each individual unit of currency worth
less.

Cost-Push Effect

Increasing the cost of one production component causes the price of the finished
good to increase as well. When the price of coffee beans increases, the price of
lattes at the local coffee shop also increase. When the price of oil increases,
transportation costs for all goods rise. Those increasing transportation costs
pass through to the retail price of all goods. So, increases in the cost of raw
materials ultimately lead to increases in the inflation rate, as manufacturers at
various levels of supply chains pass costs on to their customers, and ultimately
to individual consumers.

Demand-Pull Effect
In a strong, healthy economy, wage rates and household wealth increase. When
people have more money in their pockets, they can spend more on goods and
services. Holding supply steady while increasing the demand for goods and
services results in increased prices, since people are effectively bidding agains
each other for the limited supply of goods, whether they're houses or
hamburgers. Strong demand without an increase in supply results in higher
prices and a higher inflation rate.

What causes inflation, and

does anyone gain from it?
By Investopedia | Updated January 22, 2018 — 1:05 PM EST

A:
Inflation affects everything around us, from basic necessities like
housing, food, medical care and utilities to the cost of cosmetics and
new automobiles. Furthermore, inflation can effortlessly deteriorate our
savings. It makes the money saved today less valuable tomorrow,
eroding our future purchasing power and even interfering with our ability
to retire.

Central banks monitor inflation closely, as it is the overriding force

behind monetary policies. These are the monetary policies that impact
the level of money supply and the availability of credit within an
economy. Central banks of developed economies, including the Federal
Reserve in the United States, generally aim to keep the inflation rate
around 2%. In this article, we will examine the fundamental factors
behind inflation, different types of inflation and who benefits from it.
Causes of Inflation
Consumer Confidence: When unemployment is low and wages are
stable, consumers are more confident and more likely to spend money.
This confidence drives up prices as manufacturers and providers charge
more for goods and services that are in high demand. One example is
the market for new housing. In a booming economy, people purchase
more new houses. Contractors experience greater demand for their
services, and they raise their prices to capitalize on that demand.
Similarly, the building materials included in the houses also cost more as
supplies dwindle and consumers increase what they are willing to pay to
complete the project. (For related reading, see: How Inflation and
Unemployment Are Related.)

Decreases in Supply: One of the basic causes of inflation is the

economic principle of supply and demand. As demand for a particular
good or service increases, the available supply decreases. When fewer
items are available, consumers are willing to pay more to obtain the
item. Supply decreases for several reasons. Oftentimes a natural
disaster or environmental effect is at fault for a supply-chain interruption,
such as when a tornado destroys a factory or a severe drought kills
crops. Supplies also decrease when an item is immensely popular, a
phenomenon that frequently is seen when new cellphones or video
games are released.

Corporate Decisions: Sometimes inflation happens naturally as

supplies decrease and demand increases, but other times it is
orchestrated by corporations. Companies that make popular items
frequently raise prices simply because consumers are willing to pay the
increased amount. Corporations also raise prices freely when the item
for sale is something consumers need for everyday existence, such as
oil and gas.

Decisions made by business owners can cause inflation even when it

wasn't the intended effect. Farmers often decide to thin their cattle herds
when the price of feed increases. That decision saves the farmers
money, but it means that less beef is available for sale, driving up the
price and sparking inflation. (For related reading, see: Inflation's Impact
on Stock Returns.)

How Inflation Rates Are Determined

The inflation rate is determined by the rate of change in a price index.
The most cited and analyzed price index in the United States is
the Consumer Price Index for All Urban Consumers (CPI-U), which is
released by the Bureau of Labor Statistics each month . The Consumer
Price Index for All Urban Consumers is a weighted basket of goods and
services, ranging from food and beverage to education and recreation. A
second, often-quoted price index is the producer price index (PPI), which
includes things like fuels and farm products (meats and grains), chemical
products and metals. The producer price index reports the price changes
that affect domestic producers, and you can often see these prices
changes being passed on to the consumers some time later in the
Consumer Price Index.

Types of Inflation
Cost-Push Inflation
Cost-push inflation is one of two main types of inflation within an
economy. It refers to rising costs of production (usually in the form of
wages) contributing to increasing pricing pressure. One of the signs of
possible cost-push inflation can be seen in rising commodity prices, as
commodities like oil and metals are major production inputs.

Wages also affect the cost of production as the single biggest expense
for businesses. Analysts and policy makers currently see the labor
market, through the unemployment rate, as the most important
production input. As shortages in labor can create pressure to raise
wages, it flows naturally that the lower the unemployment rate, the
higher the possibility of labor shortages.
Demand-Pull Inflation
While cost-push inflation is a supply-side issue, demand-pull
inflation occurs when high demand causes rising prices. Demand-pull
inflation can be caused by factors such as the following:

 Expansionary fiscal policy. By lowering taxes, governments can

increase the amount of discretionary income for both business and
consumers. Businesses may spend it on capital improvements,
employee compensation or new hiring, among other things.
Consumers may purchase more nonessential items. Furthermore,
as the government stimulates the economy by increasing its
spending, say by undertaking major infrastructure projects, the
demand for goods and services will increase, leading to price
increases.
 Devaluation of the currency. Currency devaluation can lead to
higher exports (as our goods become suddenly less expensive and
thus more attractive to foreign buyers) and this increases
aggregate demand for our goods and services. Higher demand can
lead to high prices. Currency devaluation can also result in lower
imports (as foreign goods become suddenly more expensive to
purchase with devalued dollars).
 Expansionary monetary policy. Through open market operations,
central banks can increase the money supply and create a surplus
of liquidity that can bring down the value of money vis-à-vis the
price of goods. In other words, by expanding the money supply, the
purchasing power of all the participants in an economy increases,
leading to a rise in aggregate demand. If the supply of goods do
not adjust with this excess demand, then there will upwards
pressure on prices. (See also: Cost-Push Inflation Versus Demand-
Pull Inflation.)

Inflationary Expectations
Once inflation becomes prevalent enough in an economy, the
expectation of further inflation becomes an overriding concern in the
consciousness of consumers and businesses alike. These expectations
then become a guiding principle behind the actions of these economic
agents, causing inflation to persist in an economy long after the initial
shock has dissipated.

The Benefits of Inflation

While consumers experience little benefit from inflation, some individuals
reap the rewards. Manufacturers can charge more for their products and
contractors can raise their prices. Business owners can deliberately
withhold supplies from the market, allowing prices to rise to a favorable
level. Investors also enjoy a boost if they hold assets in the markets
affected by inflation. (For related reading, see: How to Benefit from
Inflation.)

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What causes inflation, and
does anyone gain from it?
By Investopedia | Updated January 22, 2018 — 1:05 PM EST

A:
Inflation affects everything around us, from basic necessities like housing, food,
medical care and utilities to the cost of cosmetics and new automobiles.
Furthermore, inflation can effortlessly deteriorate our savings. It makes the
money saved today less valuable tomorrow, eroding our future purchasing power
and even interfering with our ability to retire.

Central banks monitor inflation closely, as it is the overriding force behind

monetary policies. These are the monetary policies that impact the level of
money supply and the availability of credit within an economy. Central banks of
developed economies, including the Federal Reserve in the United States,
generally aim to keep the inflation rate around 2%. In this article, we will examine
the fundamental factors behind inflation, different types of inflation and who
benefits from it.

Causes of Inflation
Consumer Confidence: When unemployment is low and wages are stable,
consumers are more confident and more likely to spend money. This
confidence drives up prices as manufacturers and providers charge more for
goods and services that are in high demand. One example is the market for new
housing. In a booming economy, people purchase more new houses.
Contractors experience greater demand for their services, and they raise their
prices to capitalize on that demand. Similarly, the building materials included in
the houses also cost more as supplies dwindle and consumers increase what
they are willing to pay to complete the project. (For related reading, see: How
Inflation and Unemployment Are Related.)

Decreases in Supply: One of the basic causes of inflation is the economic

principle of supply and demand. As demand for a particular good or service
increases, the available supply decreases. When fewer items are available,
consumers are willing to pay more to obtain the item. Supply decreases for
several reasons. Oftentimes a natural disaster or environmental effect is at fault
for a supply-chain interruption, such as when a tornado destroys a factory or a
severe drought kills crops. Supplies also decrease when an item is immensely
popular, a phenomenon that frequently is seen when new cellphones or video
games are released.

Corporate Decisions: Sometimes inflation happens naturally as supplies

decrease and demand increases, but other times it is orchestrated by
corporations. Companies that make popular items frequently raise prices simply
because consumers are willing to pay the increased amount. Corporations also
raise prices freely when the item for sale is something consumers need for
everyday existence, such as oil and gas.

Decisions made by business owners can cause inflation even when it wasn't the
intended effect. Farmers often decide to thin their cattle herds when the price of
feed increases. That decision saves the farmers money, but it means that less
beef is available for sale, driving up the price and sparking inflation. (For related
reading, see: Inflation's Impact on Stock Returns.)

How Inflation Rates Are Determined

The inflation rate is determined by the rate of change in a price index. The most
cited and analyzed price index in the United States is the Consumer Price Index for
All Urban Consumers (CPI-U), which is released by the Bureau of Labor
Statistics each month . The Consumer Price Index for All Urban Consumers is a
weighted basket of goods and services, ranging from food and beverage to
education and recreation. A second, often-quoted price index is the producer price
index (PPI), which includes things like fuels and farm products (meats and grains),
chemical products and metals. The producer price index reports the price
changes that affect domestic producers, and you can often see these prices
changes being passed on to the consumers some time later in the Consumer
Price Index.

Types of Inflation
Cost-Push Inflation
Cost-push inflation is one of two main types of inflation within an economy. It refers
to rising costs of production (usually in the form of wages) contributing to
increasing pricing pressure. One of the signs of possible cost-push inflation can
be seen in rising commodity prices, as commodities like oil and metals are major
production inputs.

Wages also affect the cost of production as the single biggest expense for
businesses. Analysts and policy makers currently see the labor market, through
the unemployment rate, as the most important production input. As shortages in
labor can create pressure to raise wages, it flows naturally that the lower the
unemployment rate, the higher the possibility of labor shortages.

Demand-Pull Inflation
While cost-push inflation is a supply-side issue, demand-pull inflation occurs
when high demand causes rising prices. Demand-pull inflation can be caused by
factors such as the following:

 Expansionary fiscal policy. By lowering taxes, governments can increase

the amount of discretionary income for both business and consumers.
Businesses may spend it on capital improvements, employee
compensation or new hiring, among other things. Consumers may
purchase more nonessential items. Furthermore, as the government
stimulates the economy by increasing its spending, say by undertaking
major infrastructure projects, the demand for goods and services will
increase, leading to price increases.
 Devaluation of the currency. Currency devaluation can lead to higher exports
(as our goods become suddenly less expensive and thus more attractive to
foreign buyers) and this increases aggregate demand for our goods and
services. Higher demand can lead to high prices. Currency devaluation
can also result in lower imports (as foreign goods become suddenly more
expensive to purchase with devalued dollars).
  Expansionary monetary policy. Through open market operations, central
banks can increase the money supply and create a surplus of liquidity that
can bring down the value of money vis-à-vis the price of goods. In other
words, by expanding the money supply, the purchasing power of all the
participants in an economy increases, leading to a rise in aggregate
demand. If the supply of goods do not adjust with this excess demand,
then there will upwards pressure on prices. (See also: Cost-Push Inflation
Versus Demand-Pull Inflation.)

Inflationary Expectations
Once inflation becomes prevalent enough in an economy, the expectation of
further inflation becomes an overriding concern in the consciousness of
consumers and businesses alike. These expectations then become a guiding
principle behind the actions of these economic agents, causing inflation to persist
in an economy long after the initial shock has dissipated.

The Benefits of Inflation

While consumers experience little benefit from inflation, some individuals reap
the rewards. Manufacturers can charge more for their products and contractors
can raise their prices. Business owners can deliberately withhold supplies from
the market, allowing prices to rise to a favorable level. Investors also enjoy a
boost if they hold assets in the markets affected by inflation. (For related reading,
see: How to Benefit from Inflation.)
MANILA, Philippines – The country's inflation in August accelerated to 6.4%, a
level which hasn't been seen in nearly a decade.

The numbers look much worse when broken down per region.

Bicol's inflation rate is the highest at 9%.

There are also 7 more regions with inflation rates higher than the national
average – the Autonomous Region in Muslim Mindanao (ARMM),
Soccsksargen, Western Visayas, Cagayan Valley, Davao Region, National
Capital Region (NCR), and Ilocos Region.
Despite the arrival of rice imports, prices remained high. Bicol once again
topped the list with the highest rice inflation rate of 12.5%. (READ: Gov't 'did
little or nothing' to stop 6.4% August inflation)
Time to dial up telcos
The telecommunications sector is one we feel should now be the chief beneficiary of
inflation. The sector was out of favour in 2016 and was the worst performer in the
European market as investors mistakenly conflated telcos with bond proxies1. As a
result, valuations are inexpensive and the sector is far from being over-owned.

After a period of intense competition between telco operators, we are now seeing
ongoing market repair in many European countries. This is taking place with tacit
government and regulatory acceptance, as incumbents need to invest in fibre and 5G
mobile networks. Crucially, we think this investment in fibre and 5G will be
adequately remunerated.

Opportunity in banks has diminished

Signs that inflation is coming back are fantastic for financials. Bank share prices have
already seen significant gains in the latter half of 2016. Following this period of
strong performance, we feel that the outsized valuation opportunity in banks has
diminished, although there is certainly still scope for substantial profit improvements.

Within financials generally we particularly like insurance stocks. Insurers remain

decent value and are less volatile than banks. They are also a clear
reflation2 beneficiary, as this enables them to invest their income into bonds at higher
yields.

Wage inflation benefits consumer stocks

Certain consumer stocks could also be among the gainers from the current reflationary
environment. A classic business cycle investing approach would be to avoid consumer
cyclical3 stocks while commodity prices and bond yields are rising.
However, that may not be the best approach right now given their underperformance
already and with bond yields likely to remain low for now, albeit rising from the
ludicrous current levels.

Indeed, while the interest rate hiking cycle in the US has started, it is proceeding
slowly and other central banks seem to be deliberately behind the curve with regards
to inflation.

At the same time, labour markets are tightening, so we could have a case of higher
inflation due as much to higher wages as anything else. This would be a favourable
environment for the consumer. We also note that many consumer stocks – such as
auto parts suppliers and retailers – look cheaply valued on current earnings estimates.

In short, our view is that investors need to be looking for the value opportunities in
Europe right now. We feel many higher quality parts of the market, which have been
valued highly on the back of low interest rates, could continue to see their share prices
struggle.

Sectors mentioned are for illustrative purposes only and not a recommendation to buy
or sell.