What Causes Inflation: Demand, Costs, Money and Expectations

The five causes of inflation at a glance

US consumer prices rose 3.7 percent in the 12 months to September 2026, according to the Bureau of Labor Statistics (BLS), against 9.1 percent at the June 2022 peak. The causes behind those two readings overlap only in part. The table sets out each cause, how it works, and the evidence from both episodes.

The groups are not exclusive. An oil shock is a cost-push event, but how far it spreads into wages and rents depends on expectations and on how the Federal Reserve responds. Most real episodes mix several of them.

Demand-pull inflation: too much spending, too few goods

Demand-pull inflation starts with buyers. When households, businesses and government together try to buy more than the economy can produce, sellers raise prices rather than run out of stock. It is most likely when unemployment is low and capacity is tight.

The pandemic years are the clearest modern case. Lockdowns closed restaurants, travel and gyms, so spending moved to goods. Inflation-adjusted spending on goods rose 18 percent between February 2020 and April 2021, according to the Bureau of Economic Analysis (BEA). Households had the means: the personal saving rate reached 31.8 percent in April 2020, against 7.5 percent in February. Supply chains built for the old pattern could not keep up, and used car and truck prices rose 45.2 percent in the 12 months to June 2021.

As spending moved back to services, the pressure moved with it. CPI services excluding energy peaked at 7.3 percent in February 2023 and shelter at 8.2 percent in March 2023, months after goods inflation had cooled.

In 2026 demand is firm, without the extremes of 2021. The Federal Open Market Committee (FOMC) said in September that economic activity was expanding at a solid pace and that productivity growth was strong, and the minutes of that meeting record officials saying surging AI-related investment was adding to inflation pressure. Unemployment was 4.2 percent in September 2026.

Cost-push inflation: when inputs get dearer

Cost-push inflation starts with sellers. When something used across the economy becomes more expensive, energy above all, businesses pass part of the cost on. Output can fall at the same time, which is why cost shocks are the usual route to stagflation.

Energy drove the peak of both modern episodes. West Texas Intermediate crude reached $123.64 a barrel on 8 March 2022, and the CPI energy index rose 41.6 percent in the 12 months to June 2022, the month headline inflation peaked at 9.1 percent. Gasoline alone was up 59.9 percent.

2026 repeated the pattern on a smaller scale. WTI averaged $60.04 a barrel in January and $102.13 in May, and regular gasoline rose from $2.99 a gallon in the week of 1 December 2025 to $4.50 in the week of 11 May 2026, according to the Energy Information Administration. In March, BLS reported a 21.2 percent one-month jump in the gasoline index, which accounted for nearly three quarters of that month's rise in the all items index. From June the FOMC attributed elevated inflation in part to "supply shocks that have driven price increases in certain sectors, including energy," and linked the uncertainty to the conflict in the Middle East.

Tariffs work the same way: an import tax raises the cost of the goods it covers. In the September 2026 minutes, Fed staff put the rise in inflation from a year earlier down mostly to "the effects of past tariff increases, higher energy and input costs stemming from geopolitical developments, and an increase in technology-related consumer goods prices associated with the AI buildout." The CPI shows the tariff channel less clearly: prices of goods excluding food and energy were up 0.7 percent in the 12 months to September 2026.

A cost shock on its own raises the price level once. It turns into lasting inflation when it spreads into wages, rents and expectations, or when policy accommodates it.

Money supply and the Federal Reserve

The Fed's own strategy statement is blunt on this point: "The inflation rate over the longer run is primarily determined by monetary policy." The Fed acts through the price of credit, its policy rate, and through its balance sheet, which affects the quantity of money and bank reserves.

From March 2020 the Fed held its target range at 0 to 0.25 percent and bought government debt on a large scale. Its Treasury holdings rose from $2.50 trillion on 4 March 2020 to a peak of $5.77 trillion in June 2022. The M2 money supply grew 26.8 percent in the 12 months to February 2021, the fastest rate in a series that starts in 1959, and was 40.5 percent larger in March 2022 than in February 2020. Over 2010 to 2019, M2 had grown about 6.1 percent a year.

The reversal was just as sharp. Between March 2022 and July 2023 the Fed raised its target range to 5.25 to 5.5 percent and began shrinking its balance sheet. M2 started falling on a year-earlier basis in December 2022, for the first time in the series, and was down 4.7 percent in the 12 months to April 2023. Energy turned too: by December 2023 the CPI energy index was 2.0 percent below its level a year earlier, and headline inflation was 3.4 percent.

Money growth in 2026 looks ordinary by comparison. M2 rose 5.7 percent in the 12 months to September 2026, close to its pre-pandemic pace. The Fed cut its rate three times between September and December 2025, to 3.5 to 3.75 percent, held it through July 2026, then raised it on 16 September 2026 to 3.75 to 4 percent, its first increase since July 2023. The statement said the move "will support a timelier return to the Committee's 2 percent goal."

Expectations: the self-fulfilling part

If businesses expect their costs to keep rising, they raise prices in advance; if workers expect higher prices, they push for higher pay. Expected inflation then becomes actual inflation. Central banks treat stable long-term expectations as the line between a one-off price shock and a lasting inflation.

Short-term expectations moved a long way in the last surge. The University of Michigan's measure of expected inflation over the next 12 months reached 5.4 percent in March and April 2022, against 2.3 percent in December 2019. The five-year breakeven inflation rate, implied by the gap between ordinary and inflation-protected Treasury yields, hit 3.59 percent on 25 March 2022, the highest since the series began in 2003. Average hourly earnings were up 5.9 percent on a year earlier in March 2022. Survey measures are noisy, though: the Michigan figure hit 6.6 percent in May 2025, a year in which 12-month CPI inflation never went above 3.0 percent.

In 2026 the Michigan measure rose from 3.4 percent in February to 4.6 percent in September, while the five-year breakeven stood at 2.47 percent on 26 October 2026, well below its 2022 high. The September minutes say longer-term expectations remained stable at levels consistent with 2 percent, and that several officials saw short-term measures as elevated. Some warned that "after more than five years of inflation above 2 percent," elevated inflation could begin to affect expectations and wage- and price-setting. On the Fed's preferred PCE inflation measure, the 12-month rate has been above 2 percent every month since March 2021.

Government deficits and inflation

A deficit adds to demand: the government spends more than it collects and borrows the difference. How much of that reaches prices depends on how much spare capacity the economy has and on how the borrowing is financed. When the central bank buys the debt and holds rates near zero, deficit spending and money growth reinforce each other.

That combination was in place in 2020 and 2021. The federal deficit was $3.1 trillion in fiscal 2020 and $2.8 trillion in fiscal 2021, against $984 billion in fiscal 2019, and the Fed's Treasury holdings more than doubled between March 2020 and September 2021, to $5.43 trillion.

Fiscal 2026 is a different mix. The deficit was $1.99 trillion in the year to 30 September 2026, up from $1.78 trillion in fiscal 2025, according to the Monthly Treasury Statement. This time the Fed is raising rates rather than buying, and its Treasury holdings, at $4.57 trillion on 21 October 2026, are below their 2022 peak. A deficit of that size outside a recession still holds demand above where it would otherwise be, which leaves more of the work of restraining prices to the Fed.

What is causing inflation in 2026

Headline CPI inflation rose from 2.4 percent in January 2026 to 3.7 percent in September, while core inflation, which excludes food and energy, stayed between 2.4 and 2.9 percent all year. A wide gap between the two is the signature of a cost shock concentrated in energy.

Ranked by evidence, cost-push from energy comes first, followed by the tariff and AI-related goods effects the Fed staff identified. Demand is solid without the extremes of 2021, money growth is near its old average, and the fiscal deficit is large. The second-round test is expectations: whether headline inflation above 3 percent since March, after five years above the Fed's target, moves wages and long-term expectations. In September, Fed officials' median projection was 3.7 percent PCE inflation for 2026, falling to 2.3 percent in 2027.

The month-by-month record, with release dates, is in the 2026 inflation rate tracker, and the inflation calculator shows what any of these rates does to a dollar over time.