How Inflation Impacts Businesses

By Anne Shaw and Chloe Silverman
The Hartford Small Biz Ahead | Originally published: August 31, 2022
Updated: April 14, 2023

Inflation has been rising at record-breaking rates. How can inflation affect a business? What are its drivers, and will it ever slow down? Let’s start by understanding inflation and the various factors that contribute to it. We’ll then discuss how policymakers attempt to control the inflation rate before covering what small business owners can do to preserve their company’s finances during high inflation.

What Is Inflation?

As you look back over the decades, you can easily track rising prices—for a gallon of gas, a cup of coffee, nearly anything you can name. Steadily rising prices are thanks to inflation. What is inflation? It’s when money’s value goes down over time. As the value of each dollar declines, prices go up, or “inflate.” A carton of eggs that used to cost $1.99 may now put you back $3.09. Wages need to keep up with higher costs of living, so an employee who used to make $10 an hour may soon make $15. Typically, this happens at a predictable rate over a period of time, and most economists agree that low, stable inflation can keep an economy healthy. But, as today’s steep price increases show, inflation has been rising at an unpredictable, alarming rate.

Throughout 2021 and into 2022, rising inflation began a steep incline. In the wake of COVID-19’s arrival, the U.S. government hoped to thwart a reactive recession by infusing stimulus money into its economy and using its central bank, the Federal Reserve, to lower interest rates. At the same time, the job market tipped in favor of candidates, driving up wages. With a higher money supply, many people suddenly felt flushed with cash. And they spent it with confidence, increasing consumer demand. But the pandemic had wreaked havoc on the supply chain. Raw material shortages and factory shutdowns slowed manufacturing. And once goods were finally ready, they met transportation delays. The supply side of the global economy floundered. It simply hasn’t kept up with increasingly strong demand.

What Causes Inflation?

Many factors can be cited as causes of inflation, such as a supply and demand imbalance or a growing money supply (even cryptocurrency isn’t immune). The money supply can grow when a country’s banking system increases the amount of available credit or when governments simply print more money. Yet, the recipe for inflation isn’t usually that simple. To explore other factors that lead to inflation, it can be helpful to break them into three main categories: Demand-pull effect, cost-push effect and built-in inflation.

Demand-Pull Effect

When there’s an increase in the money supply, consumer demand often goes up too. During times like these, the demand for goods grows beyond what an economy can produce. This leads to scarcity, so prices rise. Economists call this demand-pull inflation.

Cost-Push Effect

The cost-push effect often starts with higher-priced raw materials, especially ones that are central to supply chains. When businesses experience consistent rises in their production costs, whether due to scarce raw materials or high energy prices, they must eventually push those costs forward by raising prices for their customers. Economists call this cost-push inflation.

Another version of this effect is called “wage-push inflation.” It occurs when rising wages increase the cost to do business and eventually result in higher prices for end buyers.

Built-in Inflation

Most people now expect that inflation is inevitable. With this in mind, people expect their wages to go up. Compensation increases to keep pace with inflation’s higher prices. Then, the economy adjusts to raised wages, and businesses raise prices. This cycle is often called a wage-price spiral. As each factor continues to influence the other, we see built-in inflation.

…[MORE]

+

To read the entire article by Anne Shaw and Chloe Silverman at The Hartford Small Biz Ahead website, visit: How Inflation Impacts Businesses