What do we call inflation caused by a rightward shift of ad?

Demand-pull inflation is a period of inflation which arises from rapid growth in aggregate demand. It occurs when economic growth is too fast.

If aggregate demand (AD) rises faster than productive capacity (LRAS), then firms will respond by putting up prices, creating inflation.

• Inflation – a sustained increase in the price level.
• Demand-pull inflation – inflation caused by AD increasing faster than AS.

Demand-pull inflation means:

• Excess demand and ‘too much money chasing too few goods.’
• The economy is at (or ver close to) full employment/full capacity.
• The economy will be growing at a rate faster than the long-run trend rate.
• A falling unemployment rate.

How demand-pull inflation occurs

If aggregate demand is rising at 4%, but productive capacity is only rising at 2.5%; firms will see demand outstripping supply. Therefore, they respond by increasing prices.

Also, as firms produce more, they employ more workers, creating a rise in employment and fall in unemployment. This increased demand for workers puts upward pressure on wages, leading to wage-push inflation. Higher wages increase the disposable income of workers leading to a rise in consumer spending.

Economic growth and long-run trend rate

The long trend rate of economic is the sustainable rate of economic growth; it is the rate of economic without any demand-pull inflation. If economic growth exceeds this long-run trend rate, then it will cause inflationary pressures.

In a boom, growth is above the long-run trend rate, and it is in this situation where we will get demand-pull inflation.

Causes of demand-pull inflation

• Lower interest rates. A cut in interest rates causes a rise in consumer spending and higher investment. This boost to demand causes a rise in AD and inflationary pressures.
• The rise in house prices. Rising house prices create a positive wealth effect and boost consumer spending. This leads to a rise in economic growth.
• Rising real wages. For example, unions bargaining for higher wage rates.
• Devaluation. Devaluation in the exchange rate increases domestic demand (exports cheaper, imports more expensive). Devaluation will also cause cost-push inflation (imports more expensive)

Demand pull inflation and Phillips Curve

Demand-pull inflation can also be shown on a Phillips Curve. A rise in demand causes a fall in unemployment (from 6% to 3%) but an increase in inflation from inflation of 2% to 5%.

Examples of demand pull inflation

From 1986, inflation increased to 1991. This was an example of demand-pull inflation.

The inflation of the late 1970s was due primarily to cost-push factors (wages/oil prices of 1970s)

UK 1980s-91

During the late 1980s, the rate of economic growth in the UK rose to over 4%.  The high rate of economic growth was caused by demand-side factors, such as:

• Rising house prices
• Cut in real interest rates
• Cut in income tax rates.
• Rise in consumer confidence

The rapid growth in demand saw inflationary pressures increase.

US late 1960s

Rapid economic growth in the mid-1960s, caused inflation to increase from 2% in 1966 to 6% by 1970.

Demand pull inflation and other types of inflation

Demand pull inflation could occur with:

• Cost-push inflation (rising costs of production). For example, in the early 1970s, economic growth and rising oil prices caused a spike in US inflation of 12% by 1974.
• Built-in inflation. Inflation has its own momentum. High inflation in previous years, makes future inflation more likely as firms put up prices in anticipation of repeated inflation.

Decline of demand pull inflation

In recent years, demand-pull inflation has become quite rare. The small rises in inflation (2008/2001) were primarily due to cost-push factors. In recent decades, we have not witnessed any significant demand-pull inflation. this is due to several factors

• Independent Central Banks responsible for monetary policy and keeping inflation to a target of 2%
• Secular stagnation. Lower rates of economic growth
• Downward pressure on prices from the global economy. Deflation of manufactured goods in Asia.
• New technology leading to lower prices.
• See also: fall in global inflation

Related

• Causes of inflation
• Boom and bust economic cycles

Demand-pull inflation exists when aggregate demand for a good or service outstrips aggregate supply. It starts with an increase in consumer demand. Sellers meet such an increase with more supply. But when additional supply is unavailable, sellers raise their prices. That results in demand-pull inflation, also known as "price inflation."

It is the most common cause of inflation. The other reason, cost-push inflation, is rarer. It starts with a decrease in total supply or an increase in the cost of that supply. Suppliers raise prices because they know consumers will pay it. That situation is called "inelastic demand."

There are six causes of demand-pull inflation

The first is a growing economy. When families feel confident, they spend more instead of saving. They expect to get raises and better jobs. They know their homes and other investments will increase in value. They feel that the government is doing the right thing in guiding the economy. They will also borrow more, either with auto or home loans, or credit cards. If they don't borrow too much, this is a healthy cause of inflation. It creates gradual and steady price increases.

Former Federal Reserve Chairman Ben Bernanke explained it this way. Once people expect inflation, they will buy things now to avoid higher future prices. That increases demand, which then creates demand-pull inflation. Once the expectation of inflation sets in, it's hard to eradicate. For example, businesses expected higher interest rates and inflation in the 1970s. That created galloping inflation. At the same time, President Nixon imposed wage-price controls which slowed economic growth. The combination created stagflation.

As U.S. Federal Reserve chairman, Bernanke set an inflation target of 2 percent. That supports a healthy economic growth rate of between 2 - 3 percent. The target uses the core inflation rate. It eliminates volatile food and energy costs. 

That's when there is too much money chasing too few goods. That occurs when the government prints too much money. It does this to pay off its debt. Oversupply of money is the primary driver of hyperinflation. It can also occur if the Fed puts too much credit into the banking system. ​

Government spending drives up demand according to Keynesian economic theory. For example, military spending raises prices for military equipment. When the government lowers taxes, it also drives demand. Consumers have more discretionary income to spend on goods and services. When that increases faster than supply, it creates inflation. For example, tax breaks for mortgage interest rates increased demand for housing. Government sponsorship of mortgage guarantors Fannie Mae and Freddie Mac also stimulated demand. Although there were many other reasons for the housing bubble, they wouldn't have been as attractive without government fiscal policies. 

Marketing can create high demand for certain products, a form of asset inflation. A great example is Apple products, including the iPod, iPad, and iPhone. Prices for these goods are higher than comparable products. That's because the consumer feels Apple understands their needs, including emotional ones. There is a certain cachet to owning an Apple product. That allows Apple to charge higher prices.

A company that creates a new technology owns the market until other companies figure out how to copy it. People will demand products with technologies that create real improvement in their daily lives. The new technology also creates a cachet for those who must own the latest gadget. For example, Tesla's electric sports car was a technological breakthrough. It used new advanced motors, powertrains, and battery packs. It is so successful that it sells these parts to other auto companies. 

Another example of technological innovation was in financial products. Credit default swaps were a new type of insurance product. They guaranteed against default on mortgages and other kinds of loans. This coverage generated higher demand for another innovation, asset-backed securities. These allowed securities that tracked the prices of mortgages to be sold on a secondary market, much like stocks.

These securities could not have been created without another technological innovation, super-computers. They process the value of these complex derivatives. As demand for the securities rose, so did the price of the underlying assets, houses. When inflation only hits one asset category, it's known as "asset inflation." Banks' demand for mortgages to underwrite the derivatives drove housing price inflation until 2006. That's when supply finally caught up with demand and home prices started to fall. It helped create the financial crisis of 2008.

The Fed overexpanded the money supply at the same time. It lowered the fed funds rate to 1 percent in 2003 to combat the recession. It remained there for a year. Inflation rose to 3.3 percent. Housing prices rose more, creating a bubble.

Deregulation allowed banks to push mortgages onto everyone. When people could borrow for almost nothing, and needed no money down, it made no sense to rent. With low-interest rates, homeowners used their homes as ATMs. They spent their home equity on medical care, housing, and consumer goods. But inflation only showed up in home prices and healthcare. The price of everything else didn't rise, thanks to China. It kept its currency, the yuan, pegged to the dollar. That artificially lowered the prices of its exports to the United States.

After the 2008 financial crisis, asset inflation occurred in gold and oil prices. Deflation occurred in housing prices and personal income. Demand-pull inflation continued in gold prices until they reached a record. That was $1,918 an ounce in August 2011. Demand for gold rose as investors worried about the eurozone crisis and the U.S. debt default crisis. As a result, they bought gold as a hedge against a collapse of either the dollar or the euro.

Demand-pull inflation creates higher prices, because it shifts the demand curve to the right. More buyers want more products and services. If the supply doesn't increase proportionally to demand, then buyers will pay higher prices for the limited supply.

Contractionary fiscal policies reduce the level of spending in the economy. When governments want to reduce inflationary conditions, they will use contractionary measures, such as raising taxes or reducing government spending.