Causes of inflation – a Monetarist perspective

20-minute summary by Prof. John Hearn

Cost-push inflation is a myth. Rising prices do not cause inflation unless you have more units of money to spend.

Demand-pull — caused by an expanding supply of money and its effect on aggregate demand — is only way you get inflation.

Managers of the money stock (central banks) are the cause.

If you only have £100 to spend and the price of gas goes up, you can still only spend £100. The relative prices of the basket of goods you purchase will adjust to find a new equilibrium.

But if the government borrows an extra £10 from the central bank, increasing the stock of money, prices will adjust to include the additional £10 spent by the government. The same basket of goods will now cost £110 and you have inflation.

That is why central banks hate monetarists. They would prefer you to believe that rising prices (cost-push) causes inflation.

Their deception is aided by the time lag between <>M and <>P of up to 2 years (<> = delta/change). From Milton Friedman’s Quantity Theory of Money: M * V = P * T (where M is money stock, V is velocity of money flow, P is prices and T is transactions)

Not all government borrowing is inflationary as it does not increase M unless debt is bought by the central bank.