Cost-Push Inflation

Cost-push inflation is associated with a supply shock — when one or more factors decrease aggregate supply and increase costs. The costs are reflected through higher prices for consumers, but it does not diminish aggregate demand.

Cost-push inflation is one of the two types of inflation. The other is demand-pull inflation.

Inflation is the increase of prices for goods and services in an economy. Inflation is triggered anytime the demand for goods and services exceeds their supply. The larger the imbalance, the higher the rate of inflation — and the larger impact it has on consumers’ personal finances. The root cause of the imbalance is generally either a demand shock or a supply shock — however, they can occur simultaneously.

Cost-push inflation occurs when the costs associated with delivering products and services increase broadly throughout an economy, but demand remains firm. This usually stems from a shortage of a key resource, such as labor or a raw material.

When lacking the necessary materials, companies are typically forced to reduce production or refuse to pay the high costs of scarce resources. Both situations put high pressure on prices. The root causes of shortages can vary.

In addition to shortages, regulatory constraints can be a source of supply-side stress. This includes things like excise taxes, minimum wage limits, healthcare mandates, environmental restrictions and product or material bans. All these constraints lead to higher costs — at least in the near-term.

Unless companies find a way to efficiently operate, despite the regulatory constraints they face, consumers are likely to face higher prices.

Demand-pull inflation differs from cost-push inflation because demand-pull inflation stems from demand-side developments, not supply-side conditions. It occurs anytime the demand for goods and services increases more rapidly than an economy’s productive capacity.

The causes vary, and most instances of demand-pull inflation are driven by a few interrelated factors. The most prominent drivers include strong economic conditions, stimulative monetary policy, expansionary fiscal policy and deeply embedded inflationary expectations.

There have been many examples of cost-push inflation throughout history. Many pertain to the volatile energy industry, particularly the oil and gas sector.

Being aware of the fluctuations for this industry can help you recognize when the economy is experiencing supply-related pressure. Then, if sensible, consumers can adjust their budget and modify their investment portfolio accordingly.

The Organization of Petroleum Exporting Countries (OPEC) is an intergovernmental organization consisting of 13 oil-exporting developing nations that coordinate and unify the petroleum policies of its members. It controls most of the world’s oil reserves and has a significant influence over oil prices.

In 1973, a geopolitical conflict prompted OPEC to place an oil embargo on the U.S. and other countries. Simultaneously, it cut oil production.

The strategic maneuver led to a global fuel shortage and caused prices to skyrocket an alarming 400%. The supply shock echoed throughout the oil-reliant economy and spiked manufacturing and travel-related costs. Consumers were immediately impacted, and cost-push inflation was in full force.

The embargo was lifted in early 1974, but oil prices remained high, and the effects of the oil crisis lingered throughout the decade.

Cost-push inflation is never completely avoidable, but you can take some steps to mitigate its adverse effects. One approach is to adjust your habits when the economy experience cost flareups. Consider the following examples.

Unfortunately, cost-push inflation is often prevalent, and you won’t always be able to navigate around it.

Fortunately, you have another avenue to pursue — making tactical changes to your investment portfolio during a high inflation period. The goal is to choose assets that have a high probability of generating more income or an increase in value amid unexpected inflation. This doesn’t mean you should put all your money into these assets; rather, you should establish modest positions and find a balance.