Question

Some economists claim that inflation is always a “monetary phenomenon.” What do they mean by this claim and are they correct?

Answer 1

Inflation is often and anywhere a monetary phenomenon in the sense that it is and can only be generated by increasing the sum of money more rapidly than in production. A steady rate of moderate-level monetary growth will provide a structure within which a nation can have little inflation and much growth.

As any other asset, the value of money is dictated by the supply and demand for it (i.e., its price in terms of other things). An expansion of the money supply, keeping the demand for money constant, would cause a decrease in the value of money and a increase in price level. An expansion of the demand for money, holding the quantity constant, would cause the amount of money to rise and the price level to decrease. All shifts in price rates — and therefore all inflations and deflations should be interpreted in the sense of demand and money supply. For this reason, inflation is obviously a monetary phenomenon.

It is probably fair to say that Friedman intended a little more than this, in the circumstances under which he made the remark. He also appeared to argue that inflations of any substantial magnitude and length are often phenomena of money supply in the sense that they are triggered by excess monetary expansion, i.e., increases in money supply compared to the usual growth in demand for money that would result from the growth of real income and the trend rate of velocity shift. Although it is true that small inflations and deflations can be attributed to changing patterns in demand for currency, it can be attributed to excessive expansion in any case where inflation has been a problem

Of course, even if a price change is the result of a shift in demand for money, there is an adjustment in the supply of money that would have stopped it, but in general it is not possible for central banks to predict any increase in demand for money so that they can counter it with sufficient changes to the money supply.

During times of inflation, it has often been argued that the observed increase in price level has been the product of corporate greedy pricing or union-based greedy wage structure. However, it turns out that profit maximizing companies, even though they are monopolies and prices "regulated," would have no incentive to increase their income, increasing prices.Because businesses and employees have no motivation to increase prices and salaries above the optimum rates, sustained inflation can not be triggered by the actions of unions and companies in the absence of the central bank's excessive expansion of the money supply.