For Friedman inflation is a monetary phenomenon - given increases in the Money supply in the...

For Friedman inflation is a monetary phenomenon - given increases in the Money supply in the US and in other countries, are we seen inflation increasing? Why yes or why not?

Expert Solution

Increasing the supply of money faster than real demand growth would trigger inflation. The explanation for this is that more capital is chasing the same amount of goods. The rise in monetary demand therefore allows companies to drive up prices. If the supply of money rises at the same rate as the real production, then the prices remain the same.

Widget production rises 16.6 percent in 2002 and money supply also rises 16.6 percent. Prices remain the same and the rate of inflation is 0 percent. Moreover, in 2003, gadget production decreased by 14 percent, however the supply of money decreased by 42 percent. With the money supply increasing faster than consumption, the nominal demand is raising. Industries put up prices in response to this rise in demand and we are seeing inflation.

Germany faced heavy costs for reparations in the aftermath of World War I. The government started printing more money to satisfy those demands – so companies could afford to pay staff. That has contributed to an inflation rate explosion. Printing money had gone out of hand by the end of 1923, and the economy was suffering hyperinflation.

Zimbabwe is in a similar condition. High government debt, declining production and the need to print money to stave off a recession in the short term. This money printing contributed to an unprecedented 79,600,000,000 per cent hyperinflation in November 2008. A 98 per cent average inflation rate

If the money supply rises faster than real production in normal economic circumstances it will cause inflation.
This connection breaks down in a distressed economy (liquidity trap), leading to a decrease in circulation velocity. This is why Central Banks can increase the supply of money in a struggling economy without triggering inflation. This happened in the US between 2008-14, however, as the economy recovers and circulation velocity increases, increased supply of money is likely to cause inflation.

Rahul Sunny answered 6 hours ago

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