Causes of Inflation:

(i) Excessive growth in wages relative to productivity can cause inflationary pressures. This cause aggregate demand to increase relative to aggregate supply and pulls up prices level.

(ii) Government sector causes. Changes such as an increase in government expenditure can produce an increase in the price level in the economy via increased aggregate demand.

(iii) Price shocks. These are substantial increases in the prices of some items, for example, due to drought, floods, or massive oil price hike. These increases in the prices of these items may feed into cost of production. Aggregate output may fall and given the aggregate demand the price level is pushed up.

(iv) Excessive growth in money supply relative to the level of production in the economy. This causes the level of aggregate demand in the economy to increase relative to aggregate output, shortages occur and the price level rises.

(v) Changes in exchange rate. If the external value of the domestic currently falls relative to other nations' currencies this may be inflationary. Under this circumstance imported goods become more expensive and this may add to domestic cost and price structure in the economy fuelling inflation.

(vi) Fall in Output. Due to war, natural disaster or even high cost out put can fall and supply constrained relative to demand.