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Inflation is one of the biggest concerns for investors and retirees.

Clients often ask, “Why are prices going up?” or “Is the Federal Reserve responsible for inflation?”

The truth is, inflation isn’t just about money printing - it’s actually driven by three key forces:

1. Demand-Pull Inflation – Too much spending, not enough supply.
2. Cost-Push Inflation – Rising production costs force higher prices.
3. Monetary Inflation – Expansion of the money supply.

These three types interact in complex ways, shaping everything from housing prices to grocery bills.

In this article, we'll break down each inflation type in simple terms—and show you how they all contributed to post-pandemic price surges.

1. Demand-Pull Inflation: When Too Many Dollars Chase Too Few Goods

This happens when consumer demand outpaces supply, pushing prices higher.

Or said another way, there’s more spending power (income) chasing a limited supply of goods – and this pushes prices up.

For example, in the Middle Ages, during times of peace, there would be fewer men dying in wars. Meanwhile, they’d marry younger and have more children. And on and on.

This increased the population and therefore led to an increase in prices because the supply of goods couldn’t keep up with more mouths to feed.

In fact, this is what led Thomas Robert Malthus – a leading English economist in the 18^th century - to come up with the ‘Malthusian Trap¹’; which essentially meant population growth directly influenced food prices, wages, and the standard of living.

Put simply, human history was generally stuck in a loop when population growth outpaced² agricultural production, causing rising prices, famine, or war – thus resulting in poverty and depopulation.

Figure 1: The Malthusian catastrophe simplistically illustrated

According to some, the only way out of this multi-century-long trap was the beginning of the Industrial Revolution (early-1800s) which brought modern innovation to allow mass agricultural production. Thus, increasing supply faster than before - which kept prices from rising.

But the main takeaway here is that demand – all else being equal – can cause inflation on its own.

2. Cost-Push Inflation: When Supply Chain Disruptions Drive Up Costs

This type of inflation occurs when the supply side changes suddenly when demand is flat.

For instance:

• A major discovery of copper could lead to falling copper prices due to the increased supply.
  
• Russia’s invasion of Ukraine (2022) disrupted oil and gas supply, making energy prices spike worldwide.

Here's how it works:

Imagine demand for apples growing 1% a year. But then suddenly there’s a massive orchard failure from bad weather and apple output sinks 50%.

Thus, prices for apples would likely increase sharply amid the declining supply.

This is important because even without increased demand, prices can still rise from changes in supply (remember, it’s called demand and supply).

For those interested in charts, here’s a good technical one showing³ how cost-push inflation works (AS stands for aggregate supply; aka total output).

Thus, the main takeaway here is when supply is reduced, costs go up—leading to inflation even without demand surges.

3. Monetary Inflation: The Federal Reserve’s Role in Price Growth

This is the most volatile form of the three inflations as it can amplify demand through increased purchasing power (putting more money in people’s hands). Or lead to changes in supply as more money chases new supply sources (more money flowing into marginal investments).

But, generally speaking, increasing the money supply does increase prices only as long as people keep spending.

Now, there’s a popular misinterpretation that the Federal Reserve “prints” money. But that’s not exactly right.

Because the Fed technically doesn’t print anything. However, they can influence inflation by tinkering with bank reserves.

·     Bank reserves are the cash minimums that financial institutions must have on hand to meet central bank requirements. This is real paper money that must be kept by the bank in a vault on-site or held in its account at the central bank.

·     For example, if a financial institution holds $1,000,000 in deposits and the reserve ratio is set at 10%, then the minimum cash reserve the financial institution needs to maintain is $100,000 ($1,000,000 times 10%).

Put simply, the Fed can pump money into banks, increasing bank reserves available, and thus influencing them to lend more (or vice versa).

How does this work?

In short, when the central bank (let’s say the Fed) engages in quantitative easing (QE), they’re essentially buying assets from banks – such as U.S. treasuries – and giving them reserves instead.

Then, these banks who are now sitting on more reserves would feel influenced to lend more (aka turn the reserves into yielding loans).

Now – quantitative tightening (QT) – is the opposite.

It’s when the Fed sells its bonds and assets to banks (taking away their reserves in return). Which then influences banks to curtail new lending as their reserves have declined. Which saps money out of the system and may push prices lower (i.e. less money chasing more goods).

This may be too technical, but the gist is that monetary inflation is the most volatile of the three and can amplify price rises or declines.

The COVID Trifecta: How All 3 Inflation Types Hit at Once

From 2020-2023, the U.S. economy experienced all three inflation types simultaneously:

• Demand-Pull: Stimulus checks & low interest rates boosted consumer spending.
• Cost-Push: Global supply chain disruptions reduced supply of goods.
• Monetary Inflation: Federal Reserve policies expanded the money supply.

Meanwhile, home prices to median household income (aka pre-tax annual income of two or more people) have soared to an 80-year high of 7.40x⁴.

This implies that it now takes 7.4 years of all pre-tax median income to buy a home outright.

These are just two examples of the sharp price increases that have affected many around the country.

But how did we get here?

Here's the backdrop: when the COVID pandemic struck in March 2020, the world watched as global policymakers endeavored to mitigate potential repercussions.

Yet, their strategies had a resoundingly inflationary impact when we look at it through the three types of inflations.

1. Cost Push Inflation – when global supply chains grounded to a halt as economies worldwide shut down, resulting in a collapse in the outflow of goods.

2. Demand Pull Inflation - when U.S. government injected a substantial amount of liquidity into the system. Measures such as student-loan deferments, mortgage forbearance, PPP loans, direct stimulus checks, tax credits, and the like, augmented purchasing power, thereby artificially increasing demand as spending capacity soared.

3. Monetary Inflation - when the Fed embarked on an aggressive easing course. They implemented measures such as zeroing out interest rates, infusing reserves into banks through quantitative easing (QE), indirectly purchasing corporate bonds, and acquiring over $2 trillion in mortgage-backed securities (MBS), among others. These policies maintained loose credit conditions and artificially buoyed asset prices, especially in the real estate sector.

At that point, the Fed was pouring gasoline onto a fire. . .

Consequently, between 2020 and 2022, these three elements—supply-side, demand-side, and monetary—simultaneously fueled inflation.

And – unfortunately – this is something the U.S. economy is still dealing with as of writing.

Conclusion: What Advisors Should Tell Their Clients

Understanding the three types of inflation helps financial advisors provide valuable insights to clients.

Key Takeaways:

• Demand-pull inflation comes from too much spending.
• Cost-push inflation occurs when supply shrinks.
• Monetary inflation is driven by the Federal Reserve’s policies.
• Post-pandemic inflation was caused by all three forces acting at once.

Want to help clients understand inflation’s impact on their investments? Contact us today.

Sources

 1. https://en.wikipedia.org/wiki/Malthusianism

2. https://www.nextias.com/current-affairs/28-09-2022/the-malthusian-trap/

3. https://www.investopedia.com/articles/05/012005.asp

4. https://www.longtermtrends.net/home-price-median-annual-income-ratio/

Disclosure

This communication is general in nature and provided for educational and informational purposes only. It should not be considered or relied upon as legal, tax, or investment advice or an investment recommendation, or as a substitute for legal counsel. Any investment products or services named herein are for illustrative purposes only and should not be considered an offer to buy or sell, or an investment recommendation for, any specific security, strategy, or investment product or service. Always consult a qualified professional or your own independent financial professional for personalized advice or investment recommendations tailored to your specific goals, individual situation, and risk tolerance.

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