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If we assume a country where only demand pull inflation holds, that is no imports cost inflation or currency fluctuations are a risk, then we can assume that inflation is determined by:

  1. Consumer spending (for example for the US this should be the most important part of the economy)

  2. Government spending

Are retail sales and house sales included in the consumer spending figure?

Aside from that, are there other economic indicators (that are neither consumer spending nor government spending) that influence a country's inflation?

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  • $\begingroup$ Demand/expenditure usually also includes capital formation (investment) and exports $\endgroup$ – Henry Aug 8 '17 at 19:56
  • $\begingroup$ @HenryBy investment you mean business investment? $\endgroup$ – Jason Aug 9 '17 at 7:47
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    $\begingroup$ I mean fixed capital formation plus changes in stocks. It can be done by business or government or consumers and includes things like constructing a new building $\endgroup$ – Henry Aug 9 '17 at 7:51
  • $\begingroup$ But does fixed capital formation actually effect the basket of goods that the CPI comprises? $\endgroup$ – Jason Aug 9 '17 at 8:16
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The components of aggregate demand are government consumption, consumption, investment, net exports.

While people typically assume there is a relationship between demand shocks and inflation, this does not mean that inflation will necessarily go up whenever consumption goes up, because consumption depends not only on demand shocks but also many other things that will not necessarily affect inflation in the same way. For example, if consumption goes up because labor productivity and incomes increase, inflation may even go down. On the other hand, if the central bank decreases the interest rate, demand will increase and this will cause an increase in inflation.

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  • $\begingroup$ "For example, if consumption goes up because labor productivity and incomes increase, inflation may even go down." This seems counterintuitive. Could you please explain this? Or perhaps you mean that because productivity increased the price of goods can even go down? $\endgroup$ – Jason Aug 9 '17 at 10:23
  • $\begingroup$ Exactly. In a competitive labor market model, workers earn their marginal product and all markets clear, so a productivity shock will translate into higher wages, higher consumption, and no change in prices. In a basic New Keynesian model, a transitory productivity shock will translate into higher wages, lower inflation, and more consumption. $\endgroup$ – Tobias Aug 9 '17 at 10:51
  • $\begingroup$ Thanks, one last question: In the real world we would also count imports as impacting inflation too, correct? $\endgroup$ – Jason Aug 9 '17 at 10:56

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