Cost-push inflation is a rise in prices caused by a decline in aggregate supply, but aggregate demand holds firm or increases. This drives up the cost of goods and services and reduces purchasing power. Learn about this economic dynamic and the things you can do to hedge against it.
- Written By Thomas J. Brock, CFA®, CPA
Thomas J. Brock, CFA®, CPA
Thomas Brock, CFA®, CPA, is a financial professional with over 20 years of experience in investments, corporate finance and accounting. He currently oversees the investment operation for a $4 billion super-regional insurance carrier.Read More
- Edited ByLamia Chowdhury
Lamia Chowdhury is a financial editor at Annuity.org. Lamia carries an extensive skillset in the content marketing field, and her work as a copywriter spans industries as diverse as finance, health care, travel and restaurants.Read More
- Financially Reviewed ByStephen Kates, CFP®
Stephen Kates, CFP®
Stephen Kates is a Certified Financial Planner™ and personal finance expert specializing in financial planning and education. Stephen has expertise in wealth management, personal finance, investing and retirement planning.Read More
- Updated: February 24, 2023
- 7 min read time
- This page features 4 Cited Research Articles
What Is 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.Did You Know?When the price of a good or service increases, but demand does not decrease, the good or service is price inelastic. Conversely, when the price increases and demand decreases, the good or service is price elastic.
What Causes Cost-Push Inflation?
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.Common Drivers of Shortages
- A geopolitical shock, such as a war, an act of terrorism or a sudden trade barrier, can broadly disrupt international trade and increase the prices of inelastic goods. The U.S. experienced some of this in 2022 due to the war in Ukraine.
- Natural disasters, such as floods, earthquakes, fires and tornadoes, can cause significant supply chain disruptions. The impact is largely dependent on the extent of damage they inflict and the length of the fallout. The more catastrophic the disaster, the higher chance of cost-push inflation.
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."Cost-push inflation is the more unsettling type of inflation because it can be created by supply shocks or shortages. The effect on the economy and consumers’ wallets is the same: prices rise at an accelerated pace. To manage the rising costs, adjustments to investments and purchases may be necessary."
Cost-Push Inflation vs. Demand-Pull Inflation
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.Advertisement
Cost-Push Inflation Example
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.
1970 Oil Crisis
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.
Can You Avoid Cost-Push Inflation?
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.How To Adjust Habits During Cost-Push Inflation
- If oil prices are surging due to geopolitical issues and you’re able to work remotely, you can save money on gas by eliminating your commute. You can save even more money by using your heating, ventilating and air conditioning (HVAC) utilities wisely.
- If you’re a small-business owner and a trade conflict results in a severely limited supply of raw inputs for high-end computing equipment, you may have to postpone the upgrade you’ve been planning for your business. Productivity may decline a bit but deferring the outlay will help your bottom line.
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.Consider the following strategies:
Ask an ExpertAnnuity.org’s credentialed experts are here to help you find your path to financial freedom. Have a question for Thomas Brock about inflation?
- Large-Cap Growth Stocks
- The relatively high return potential and pricing power of these types of companies can bolster the long-term value of your portfolio.
- Gold or Real Estate
- Allocate some of your investments toward gold or real estate as they have proven to withstand the financial impacts of inflation.
- U.S. Series I Savings Bonds
- This type of savings bond earns interest based on both a fixed rate and an inflation rate. Since they are protected from inflation, they are considered a low-risk savings product.
Other Frequently Asked QuestionsHow is inflation measured?Inflation is measured by monitoring changes in a price index, which is a basket of goods and services that are representative of all goods and services utilized within in an economy. The most commonly referenced indices in the U.S. include the Consumer Price Index (CPI), the Personal Consumption Expenditures (PCE) Index and the Producer Price Index (PPI).What is the Consumer Price Index (CPI)?The Consumer Price Index (CPI) is the most widely monitored price index in the U.S. It reflects a weighted average of the prices of essential goods and services commonly used by urban households. For the twelve-month period that ended on July 31, 2022, the CPI rose 8.5%.Is inflation ever a good thing?A moderate and consistent level of inflation (2% to 3%) is generally considered a sign of economic health that encourages sustainable growth. However, unexpected and elevated levels of inflation can have a destabilizing effect on an economy and erode the purchasing power of its people. The most significant risk is for retirees living on a fixed income, as well as lower-income households.What is disinflation?Disinflation is a slowing rate of inflation. With disinflation, prices are rising but at a declining pace. This differs from deflation, which is a decrease in the price of goods and services.Advertisement
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4 Cited Research Articles
Annuity.org writers adhere to strict sourcing guidelines and use only credible sources of information, including authoritative financial publications, academic organizations, peer-reviewed journals, highly regarded nonprofit organizations, government reports, court records and interviews with qualified experts. You can read more about our commitment to accuracy, fairness and transparency in our editorial guidelines.
- Organization of the Petroleum Exporting Countries. (2022). About Us. Retrieved from https://www.opec.org/opec_web/en/17.htm
- U.S. Bureau of Economic Analysis. (2022). Personal Consumption Expenditures Price Index. Retrieved from https://www.bea.gov/data/personal-consumption-expenditures-price-index
- U.S. Bureau of Labor Statistics. (2022). Consumer Price Index. Retrieved from https://www.bls.gov/cpi/
- U.S. Bureau of Labor Statistics. (2022). Producer Price Index. Retrieved from https://www.bls.gov/ppi/
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