Demand-Pull versus Cost-Push Inflation
Demand-pull inflation comes from excess aggregate demand pulling output above its potential, so prices and output rise together. Cost-push inflation comes from an adverse supply shock, such as higher oil or wage costs, so prices rise while output falls. Cost-push is the hard case for an inflation-targeting central bank, because fighting the inflation deepens the loss in output.
Why it matters
When the economy is running hot, cooling demand lowers both inflation and the overheating at once, so the choice is easy. When costs jump from a supply shock, any tightening that curbs inflation pushes a weak economy down further, so the bank faces a genuine trade-off rather than a free win.
Worked examples
A sharp rise in world oil prices lifts inflation while output is already slowing. Why is this harder for the central bank than inflation driven by a booming economy?
This is cost-push inflation. Raising rates to curb it would weaken an already slowing economy, so the bank must trade higher inflation against lower output. Demand-pull inflation, by contrast, lets the bank cool an overheating economy and lower inflation at the same time.
Common mistakes
- ✗All inflation comes from too much money or demand. Supply shocks can drive cost-push inflation even without excess demand.
- ✗The central bank can always cure inflation at no cost. Against cost-push inflation it must choose between higher inflation and lower output, so there is a real trade-off.
- ✗Cost-push and demand-pull inflation look the same to a policymaker. They differ in what happens to output, which is exactly why cost-push is the harder case.
Revision bullets
- •Demand-pull: excess demand lifts prices and output together
- •Cost-push: a supply shock lifts prices while output falls
- •Cost-push forces a trade-off between inflation and output
Quick check
A negative supply shock that raises prices while lowering output is an example of
Connected topics
Sources
- Mishkin (2018), Ch. 24Mishkin, F. S. The Economics of Money, Banking, and Financial Markets. 12th ed. Pearson, 2018. ISBN 978-1-292-26885-9.Demand-pull and cost-push inflation and the policy trade-off that supply shocks create.