Inflation is classified into cost push inflation and demand pull inflation in terms of its origin. If inflation is demand pull, it will be caused by high demand or income with the people. On the other hand, if inflation is cost-push, it will be caused by rise in the price of inputs used in the production of commodities.
In other words, the basic difference between the two is that cost push inflation is supply side in nature whereas demand pull inflation is demand side in nature.
(a) Cost -Push inflation
Cost push inflation is caused by rise in the prices of inputs like power, labour, raw materials etc.
Price rise of inputs in the form of increased raw material cost, electricity charges or wage rate (including a rise in profit margin made by the producer) results in increased cost and ultimately to increased price of the product. An important example for cost push inflation is the rising price of coal which immediately may cause price rise in industries which use coal. Price rise of key inputs like crude oil products may trigger price spiralling effect on other goods and services. In India, cost push inflation is the major supply side factor producing inflation.
How it can be addressed?
An important factor about cost push inflation is that it can’t be managed by monetary policy intervention by the RBI; like an increase in repo rate. The ideal way to tackle production related cost push inflation is to initiate measures to augment the production of commodities. Similarly, imports also can be resorted to contain cost push inflation.
There are several conventional measures to handle cost push inflation- providing incentives like subsidies, tax cuts, and launching production boosting programmes like National Food Security Mission.
(b) Demand-pull inflation
Demand pull inflation is caused by increased demand in the economy, without adequate increase in supply of output. It is mainly an outcome of excess money income with the people. This high money income would be due to increased money supply. The situation of “too much money chasing too few goods” is an instance of demand pull inflation.
How it can be addressed?
Monetary policy is best fit to tackle demand pull inflation. An increase in repo rate will decrease demand for loans for consumption and production and in this way will reduce the demand for commodities. Similarly, additional taxation by the government and reduced public expenditure are also good for demand management.