The Truth behind Inflation in Nepal

You may have noticed that filling your bike, going to groceries, building your home, travelling from one place to another, have become more expensive lately. While some things are cheaper than a year ago, overall we are paying more for what we buy. This is called as Inflation.

What is Inflation?

Inflation is a measure of the rate of increase in price level of goods and services in an economy. Inflation happens when prices rise due to increase in production cost such as raw materials, energy and wages. Basically, it means that a rupee today buys less than it used to. It's usually discussed in terms of a percentage rate. So, if inflation is 5% for a packet of edible oil then it means a packet of edible oil that cost Rs.100 is now Rs.105.

Main reasons for Inflation

Economist believes that, controlled inflation is a sign of economic growth. Nepal Rastra Bank, actually set monetary policy to maintain a consistent inflation rate as projected by Nepal Government. However, over dependence on India for import of various products and services leads to inconsistent outcome from use of monetary management tools.

There are two main reasons of inflation, one is demand-pull inflation and another is cost-push inflation. Both are responsible for a rise in prices, but they each work differently.

What is Cost-Push Inflation?

Economists describe cost-push inflation as a condition when the supply of goods or services is limited in some way but demand remains the same, pushing up prices. The increased price of labor or raw materials, for example, leads to decreased supply of these goods. While demand remains constant, the prices of commodities increase causing a rise in the overall price level.

The overall price level increases due to higher costs of production which reflects in terms of increased prices of goods and commodities which primarily use these inputs. This is essentially inflation triggered by less supply.

Cost-Push Inflation is usually associated with an unexpected external event like a natural disaster, war between countries, depletion of natural resources, monopoly, government regulation, government taxation, and changes in exchange rates. Basically, any event that hinders a company’s ability to produce enough of certain goods to keep up with consumer demand. This forces them to raise or inflate prices.

Examples of Cost-Push Inflation

The most common example of cost-push inflation occurs in the energy sector - oil and coal prices.

You and pretty much everyone else need a certain amount of fuel for your vehicles and natural gas to cook at your home. When war, or natural disasters drastically reduce the oil supply, fuel prices rise because demand remains relatively stable even as supply shrinks.

What is Demand Pull Inflation?

Demand-pull inflation is the tendency for prices to increase due to increasing aggregate demand, or the amount of goods and services the entire population buys. This type of inflation is usually associated with a strong economy.

As an economy strengthens, employment tends to rise. As more people go back to work, they make more money and they spend more money. However, if goods are limited at a time when people are willing to spend more money, competition among consumers drives prices up. Economists often refer to this type of inflation as “too many rupee chasing too few goods.”

Demand-pull inflation is not limited to the consumer sector of the economy. We get a similar outcome if the government puts more money into circulation, or if a low interest rate environment encourages too much borrowing.

Examples of Demand Pull Inflation

In March of 2020, the global economy shut down due to the coronavirus pandemic. With the advent of a number of vaccines in late 2020, the global economy began to slowly open up. As the availability of vaccines increased, the pace of vaccinations rose sharply and the global economic recovery moved forward at a rapid speed.

The global economic recovery is driving up demand for goods and services that weren’t readily available for close to a year. Inventories have been depleted as consumers demand more food, household items, and fuel. This increased demand is “pulling” up prices.

Employment is rising also which means consumers have more disposable income. Gasoline demand and prices are rising as more employees drive to work. Airline tickets and hotel rooms are also rising as pent-up consumers increase travel.

Essentially, as the global economy opens up, individuals want to spend money, but factories haven’t been able to meet demand as quickly. Consumers are willing to pay higher prices, thereby, creating demand pull-inflation.