The triangle model of inflation is a way of examining inflation, derived from what is known as the Phillips Curve. In the triangle model, inflation is looked at as being driven by three distinct types of inflation: built-in inflation, cost-push inflation, and demand-pull inflation.
Built-in inflation, one of the three sides of the triangle model, is inflation that was caused at some point in the past — either by cost-push or demand-pull inflation — and continues to be a factor to this day. Because of certain principles of macroeconomics, such as what is known as the price-wage spiral, this inflation never went away. Instead, built-in inflation becomes an expected part of the economy. In the triangle model, built-in inflation makes up the base of the triangle.
Cost-push inflation, the second side of the triangle model, is also often called supply-shock inflation. Cost-push inflation happens when the cost of something within the economy goes up, and nothing can easily be substituted for it. Cost-push inflation often happens when outside suppliers of a key product or service increase their costs, and the importing economy is forced to pay higher prices.
The classic example of cost-push or supply-shock inflation is the oil crisis that occurred in the 1970s. When the Organization of the Petroleum Exporting Countries (OPEC) raised oil prices, the United States was forced to pay higher prices. Because oil is used in essentially every industry, this sent supply shockwaves throughout the United States, and overall prices went up, while wages paid stayed the same. It should be noted that not all economists agree on the existence of cost-push inflation — notable economists such as Milton Friedman argue that the ultimate cause of inflation in these cases is governmental increase of the money supply.
Demand-pull inflation, the third side of the triangle model, is perhaps the most important aspect of the triangle model of inflation. It is primarily from the Philips Curve which describes demand-pull, that the triangle model was derived. Essentially, demand-pull inflation theory stipulates that there is a point when demand for a product in a society will outstrip the society’s ability to produce that product. As unemployment levels decrease, and overall spending increases, eventually there becomes a shortage of desired products. This shortage causes those products to increase in cost — resulting in inflation.
Demand-pull inflation luckily tends to be fairly short lived in most modern economies. Because no modern society is at full employment levels — which is essentially having a 0% unemployment rate — and because technology continues to develop, output of a product can generally be increased. As output increases, the shortage is abated, and prices drop again. Often, however, prices do not drop entirely back to previous levels, resulting in some built-in inflation.
Although each of these three types of inflation might seem at first glance to be disconnected, if one looks at them more closely one begins to find connections. It is this understanding of the inter-connectedness of these three integral types of inflation that led to the formulation of the triangle model of inflation. The Philips Curve was deemed insufficient on its own to explain inflation, and the triangle model takes a further step towards better addressing most inflation in modern societies.