Why are prices rising?

So-called inflation is nothing more than the rising prices of goods in the markets. But why is there inflation? Why are prices rising?

Here are explained the reasons why prices rise

Market prices are due to the interaction between supply and demand, that is, between those who want to buy and those who want to sell. 

Basically, there can be two causes of rising prices, each due in turn to different causes. 

If price is the result of the interaction of supply and demand in the market, then it is their changes that make it vary. 

In particular, prices can increase either when supply decreases or when demand increases. Markets are for all intents and purposes competitions in which generally among buyers those who are willing to spend more win, and among sellers those who are willing to sell for less win. 

Therefore, the more demand increases, the more upward competition to buy products in the market increases. On the other hand, the more competition among sellers is reduced, the more they can afford to raise prices. 

At this precise moment in history, the rise in prices is due somewhat to both dynamics, although the one related to demand started earlier. 

In fact, one of the most classic causes of increased demand in the markets, those who want to buy, is trivially the increase in money available. The more money buyers have, the more willing they are to spend, therefore, agree to buy at higher prices. 

In the spring of 2020, the Central Banks, to cope with the collapse of the financial markets due to the onset of the pandemic, issued an immense amount of new money out of thin air, and over the following months distributed it to the financial markets. This money, after a while, also began to reach the pockets of consumers, thus making them more inclined to spend, therefore, to buy goods in the market even at higher prices than before.

What has happened in the United States and Europe

In the U.S., for example, the Fed began flooding markets with money in March 2020, but until March 2021 no above-average inflation had been generated. Since then, however, it has started to rise significantly. 

Something very similar has happened in the Eurozone with the ECB. 

In the meantime, moreover, because of the lockdowns that have reduced industrial production somewhat around the world, supply has also begun to decline. There was somewhat reduced downward competition from sellers, causing prices to rise. 

The two phenomena over the months added up, causing inflation to spike to levels not seen in at least 40 years. 

Beginning in March 2022, however, a second cause was added in Europe, namely a further decline in supply due to commodity shortages. 

To be fair, industrial production during 2022 is slowly returning to pre-pandemic levels, so one might have expected a reduction in inflation due to the resolution of one of the two problems that generated it. In fact, in the U.S. after June, inflation seems to be on a downward trend, while in Europe, it has risen again.

The problem for Europe is the reduction of gas supply on the market due to the war in Ukraine. On the one hand, many European countries have decided to reduce purchases from Russia, and on the other hand, Russia itself has decided to reduce supplies. 

The problem of the cost of gas and the level of supply from Russia

So, while in the U.S. the drop in supply began to recede at the beginning of the second half of the year, in Europe, on the other hand, the problem became even more acute. In fact, it should not be forgotten that gas is by far one of the main sources from which electricity is produced, especially in Europe, so its fast and extraordinary price increase after February 2022 has also sent electricity production costs soaring. 

The rise in both the cost of gas and electricity has had a major impact on industrial production in all sectors, including the service sector, so as a result, prices of all goods in the market have risen. 

The Central Banks for some time have started a restrictive monetary policy aimed at reducing money in circulation in the markets, while companies have returned to pre-pandemic production levels. Thus, the only cause of rising prices that remains completely unresolved is that related to Russian energy products, and in particular natural gas.

However, it should not be forgotten that Russia is by far the world’s largest exporter of natural gas. Therefore, the continuation of the current situation could prevent prices from falling significantly in the coming months, especially in Europe.