Demand-Pull Inflation

Demand-pull inflation is associated with a demand shock — when one or more factors drive aggregate demand higher, but aggregate supply does not move proportionally. Then, as buyers compete for the limited number of goods and services, the prices are increased.

Demand-pull inflation is one of two types of inflation — the other is cost-push inflation. Learn what demand-pull inflation means for your personal finances and how you can hedge against it.

Inflation is measured by monitoring changes in a price index, which is a basket of goods and services that represents all goods and services utilized within an economy.

The formula used to compute inflation is illustrated below, using the CPI for illustrative purposes.

Cost-push inflation differs from demand-pull inflation because cost-push inflation is a result of supply-side conditions, not demand-side developments. It occurs when the costs associated with delivering products or services increase broadly throughout an economy, but demand remains firm.

This can be attributed to many things, but the most common drivers are a shortage of materials, geopolitical shocks (such as war, acts of terrorism and sudden trade barriers) and regulatory constraints.

There have been many examples of demand-pull inflation throughout history. It’s important to be aware of them because it can help you recognize when the economy is reaching a similar climate. Then, if feasible, you can modify your spending habits and investment strategies, accordingly.

The Great Recession of 2007 to 2009 is largely attributable to the massive housing bubble in U.S. real estate prices. The bubble formed because of significant demand-pull inflation in the preceding years. Several factors fueled the situation, including widespread speculative home buying, predatory lending and excessive risk-taking by global financial institutions.

When real estate prices collapsed in late 2007, it resulted in the worst U.S. economic downturn since the Great Depression. The recession quickly spread worldwide, prompting unprecedented fiscal, monetary and regulatory policy that was maintained for the following decade.

In March 2020, the global economy shut down due to the coronavirus pandemic. This immediately decreased demand and froze supply chains worldwide. However, by late 2020, vaccines were introduced, which spurred a global economic recovery that advanced at a rapid speed.

In 2021, as people began to resume normal lives, the demand for some goods and services surged, including gasoline, auto parts, clothing, airline tickets, hotel rooms, catering and entertainment services. The soaring demand quickly overshadowed productive capacity, which had been diminished by the COVID-19 supply chain disruptions.

Notable demand-pull inflation occurred, and it was worsened by a range of aggressive monetary and fiscal policies implemented to stabilize financial markets and support consumers and small businesses.

The most effective way to invest during high inflation is to favor assets that have a high probability of generating high income or experiencing value increases in the face of rising prices. This doesn’t mean you should put all your money into these assets. Instead, you could consider the following strategies.

Battling inflation should never be the central focus of your portfolio. Always strive to maintain a holistic view of your investment objectives, which should reflect your time horizon. Don’t lose sight of your need for capital preservation, income generation, growth and liquidity. If you haven’t assessed these requirements or need some help doing so, consider consulting with a fiduciary financial advisor.