Options?  The Challenge of Rising Prices, and Cost-Push Inflation

The increase in prices can be broadly attributed to three main causes:

1. The normal rise in prices the central banks target (1-3%)
2. Cost-push inflation due to supply shortages
3. Government spending increasing demand-pull inflation while also devaluing the currency by significantly increasing money supply and the Debt-to-GDP ratio.

Cost-push inflation is caused by the underlying costs of a business increasing.  This could be a combination of rising costs due to commodities, supplies, labour, taxes, etc.  Generally, cost-push inflation is undesired by consumers, but will generally work itself out over time as businesses and consumers adapt to the new environment and new efficiencies are discovered for production and transportation, which reduces to costs to businesses and therefore less costs pushed onto consumers.

As prices rise, employees demand higher pay to keep up with the cost of living.  The phenomenon is logical and well recognized.  In fact, we can go all the way back to Adam Smith’s The Wealth of Nations in which he discusses the difference between the value of labour and the value of money. 

“A man must always live by his work, and his wages must at least be sufficient to maintain him.”[3] 

Smith discusses the tighter correlation of the costs of sustenance with the costs of labour than the amount of money which was exchanged for the labour to purchase such sustenance.  That is to say, wages tend to adjust with the cost of living.

Because labour costs are often a major expense for businesses, this causes prices to rise again due to cost-push inflation, and the cycle continues.  Because labour generally only represents a portion of overall costs, the recursive impact of each iteration is decreased, so the cycle is not necessarily infinite; however, the cyclical nature of the increases in costs is proportional to the impact for the business and can be significant.

The recursive impact of each iteration is decreased, so the cycle is not necessarily infinite; however, the cyclical nature of the increases in costs is proportional to the impact for the business and that can be significant[4].

Bottom Line: Inflation is higher than what we’ve seen for decades, and one of the main causes for rising prices is cost-push inflation caused by shortages in commodities, labour, and supplies.  That makes this a financially painful period for consumers, businesses and investors; one which requires a rethink of household and business budgeting, investment and retirement strategies. 

Next time: The Government of Canada has been acting through fiscal and monetary policy to affect the rate of inflation.  What have they done, and what possible motivations might they have to allow higher-than-normal inflation to stay in place?