What is inflation and what causes it in 2022?

➯ If you’re not sure how inflation works (and why it is such a big deal in 2022), this article is for you!

According to the European central bank:

“Inflation occurs when there is a broad increase in the prices of goods and services, not just of individual items.”

➯ In other words, inflation means that you can buy less for €1 today than you could yesterday.

➯ 3 mechanisms can cause inflation: demand-pull, cost-push, and built-in.

➯  When demand exceeds production capacity, prices rise.

This can either be due to higher demand, or a supply shortage.

▸ Example of higher demand

Think of a saturated area like Amsterdam. More and more people want to live in this area. The increase in demand directly drives up real estate prices, impacting the whole economy.

▸ Example of supply shortage

Take the example of the war between Russia and Ukraine. Europe restricted the amount of oil and gas it imported from Russia. As a result, we are currently facing a decrease in energy supply, which is causing a drastic increase in energy prices. That’s why your energy bills are getting more and more expensive.

➯  This type of inflation occurs when the overall cost of production increases.

▸ Example of cost-push mechanism

Re-take the example of the increased energy prices.

If companies need oil and gas to create their products, they will experience higher production costs. Since most companies see their expenses increase, they all have to increase their prices. That’s why your grocery expenses are rising.

➯  This is the third factor that generates inflation, which is often misunderstood.

▸ To understand this concept, you need a basic understanding of how money circulates in the economy.

▸ To put it simply, people receive wages from companies and spend them on products and services produced by companies.

If that were 100% true, the amount of money in the economy would never fluctuate. But it does.  

▸ When people get loans, banks create money and pass it on to the debtors.

▸ Once the loans are paid back, the amount of money created by banks is removed from the economy. And the amount of money in the economy goes back to normal.

▸ The more people get a loan, the more money is added to the economy.

▸ In an attempt to limit the amount of money in circulation, the European Central Bank can adjust the interest rate accordingly. The higher the interest rate, the fewer people can afford a loan.

➯ How does the amount of money in circulation create inflation?

It’s quite simple: if the amount of money in circulation is doubled, 1€ would be less rare. Therefore, 1€ becomes less valuable. As a result, 1€ would lose half of its value, leading to a 50% increase in prices.

Inflation is happening right before our eyes.

▸ Electricity bills, gas prices, restaurants, groceries expenses… Many products and services see their price increase daily.

▸ That’s because the economy got hit by the supply shortage due to the Covid-19 crisis.

▸ On top of that, the war between Ukraine and Russia is currently causing an energy shortage. As a result, gas, oil, and electricity prices are rising.

▸ Since all companies use energy to produce their products, their production costs increase, which forces them to raise their prices.

➯ We hope that this article was useful to you!

Now you understand what inflation is, what causes it, and why it’s happening in 2022! 🎉

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