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The Three Kinds of Inflation: Built-In Inflation

Over the last few weeks, I’ve discussed nearly every aspect of inflation itself, including two of its variations (demand-pull and cost-push inflation). Today, I’ll be exploring the final type of inflation, built-in inflation. This might be the most ironic and is by far the most self-fulfilling concept I’ve explored in one of my articles.

As a reminder, inflation is a decrease in purchasing power, meaning one dollar will be able to buy less and less as time passes. Inflation has been present throughout recent history, and will likely remain present for years to come.

Inflation degrades the “value” of cash over time, so large savings kept in cash will be worth “less” as time passes. The same item that was, say $5 in 1990, will cost $10 in 2021, despite there being no change in the item itself. Instead, due to inflation, the purchasing power of one dollar decreased over 30 years.

Now, onto built-in inflation. Unlike demand-pull and cost-push inflation, built-in inflation doesn’t have a tangible basis (changes in the money supply, increase in raw material pricing). Instead, built-in inflation occurs due to expectations.

There are two driving factors behind built-in inflation. The first is inflationary expectations. This means people expect inflation and therefore try to change their actions to adjust for it. What exactly does this entail? Well, companies expect inflation to occur, so to ensure their real (inflation-adjusted) profits stay the same, they increase prices. Similarly, workers expect inflation to occur and expect their wages to rise so they can afford changes in pricing. As such, because so many institutions expect inflation, and act to mitigate the expected effects by raising prices, they play an active role in implementing inflation (a general rise in prices). Ironic, right?

Similarly, the second driving factor for built-in inflation is the conflict between employers and employees when it comes to wages. Employees that expect inflation request higher prices, which leads to decreased profit margins for employers, as higher wages mean higher operating costs. Employers, to maintain their profits while also meeting the demands of workers, raise the prices of their goods. Consumers see increasing prices, and demand increased wages because their cost of living increased. This leads to employers raising prices, and the cycle continues. As I said, very self-fulfilling :P.

In summary, built-in inflation results from expectations of inflation. Consumers and workers expect inflation and demand higher wages, leading companies to increase prices, which raises the overall cost of living, which, in turn, leads consumers and workers to demand higher wages, causing a positive feedback loop. I hope this article was helpful, and now that we’ve explored all the different aspects of inflation, I’ll be explaining a few different ways to battle inflation in the coming weeks. Thanks for reading, and I'll catch you in the next one.

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