The money supply of a country is a major contributor to whether inflation occurs. ♊As a government evaluates economic conditions, price stability goals, and public unemployment, it enacts specific monetary and fiscal policies to promote the long-term well-being of its citizens. These moneta🐈ry and fiscal policies may change the money supply, and changes to the money supply may cause inflation.

Inflation can happen if the 澳洲幸运5官方开奖结果体彩网:money supply grows faster than the economic output under otherwise normal economic circumstances. Inflation, or the rate at which the average price of goods or services increas🍒es over time, can also be affected by factors beyond the money supply.

How Money Supply Affects Inflation

The 澳洲幸运5官方开奖结果体彩网:Federal Reserve is responsible for evaluating current market conditions and deciding whether to make changes to the money supply. The Fed makes changes to the money supply by lowering or raising the 澳洲幸运5官方开奖结果体彩网:discount rate banks pay on short-term loans. Th𝔉e Fed also❀ buys or sells securities from banks to increase or decrease the amount of money these banks have in reserves.

When the Fed increases the money supply faster than the economy is growing, inflation occurs. In this situation, the increase in money circulating in an economy is higher thanꦺ the increase in goods produced. There is now more money chasing fewer goods in this econom☂y.

For example, imagine an economy with $100 and 100 bananas. If everyone were to take their money and buy all bananas, the average price per banana would be $1. Now imagine the government increased the money supply by 10% to $110, but this fictitious economy was only able to♏ grow ban꧂ana output by 5% to 105 bananas. Since the amount of money increased more than the number of bananas, the average price per banana now increased to roughly $1.05.

Quantity Theory

The theory most discussed when looking at the link between inflation and money supply is the 澳洲幸运5官方开奖结果体彩网:quantity theory of money (QTM).

The quantity theory of money proposes that the exchange value of money is determined like any other good (through supply and demand). The QTM proposes that the exchange value of money is determined by 🔴the volume of transactions (or income) and the velocity of money in the economy.

The conceptual basis for the quantity theory was initially developed by British economists 💫David Hume and Jo🌸hn Stuart Mill.

The basic equation for the quantity theory is called the Exchange Equation. The equal is also called the 澳洲幸运5官方开奖结果体彩网:Fisher Equation because it was developed by American economist Irving Fisher.

In its simplest form, the formula is:

$\begin{aligned}&\textbf{\textit{MV=PT}}\\&\textbf{where:}\\&M=\text{Money supply}\\&V=\text{Velocity of money, an economic term}\\&\qquad\ \text{that can broadly be understood as how}\\&\qquad\text{ often money changes hands}\\&P=\text{Average price level}\\&T=\text{Volume of transactions for goods}\\&\qquad\text{ and services}\end{aligned}$​MV=PTwhere:M=Money supplyV=𝔉Velocity o📖f money, an economic term that can broadly be u🌌nderstood as&꧒nbsp;how often money changes handsP=Average price levelT=Volume ☂of transaction♋s for goods and services​

Challenges to Quantity Theory

澳洲幸运5官方开奖结果体彩网:Keynesian and other nonmonetarist economists reject orthodox interpretations of the quantity theory. Their definitions of inflation focus more on🌳 actual price increases with or without money supply considerations.

According to Keynesian economists, inflation comes in two varieties: demand-pull and cost-push. 澳洲幸运5官方开奖结果体彩网:Demand-pull inflation occurs when consumers demand goods, possibly because of the larger money supply, at a rate faster than production. 澳洲幸运5官方开奖结果体彩网:Cost-push inflation occurs when the input prices for goods tend to rise, possibly because of a larger money su﷽pply, at a rate faster than consumer preferences change.

When Changes i♍n Money Supply Do Not Cause Infla⛦tion

There are several situations where increases in the money supply do not🦹 cause inflation.

1. Economic growth may match money supply growth. If the level of 澳洲幸运5官方开奖结果体彩网:economic growth is equal to the level of money supply growth, prices traditionally remain stable.
2. There are variations in the velocity of money circulating. In a recession, the Fed may choose to increase the money supply; however, the spending patterns of consumers will vary during this period—including periods of decreased spending due to higher 澳洲幸运5官方开奖结果体彩网:unemployment and less 澳洲幸运5官方开奖结果体彩网:disposable income.
3. The economy has spare room to grow. During a 澳洲幸运5官方开奖结果体彩网:recession, an economy is not operating at full capacity. Though an increase in the money supply provides additional resources, there may be minimal to no demand for additional capital as the economy grapples with stunted economic growth.

Other Impacts of Money Supply Changes

In addition to inflation, changes to the money supply may result in similar economic conditions. If the difference between the money supply and economic growth grows wide enough, the value of a currency begins to rapidly deteriorate and the country enters into a period of 澳洲幸运5官方开奖结果体彩网:hyperinflation.

Alternatively, changes in the money supply can cause 澳洲幸运5官方开奖结果体彩网:deflationary periods. The Fed can raise 澳洲幸运5官方开奖结果体彩网:interest rates or decrease security purchases from banks. Both of these practices decrease the money supply. When the money supply decreases, there is less competition for goods and prices traditionally fall.

Example of Money Supply Impacting Inflation

As the world grappled with COVID-19, the Federal Reserve enacted policies to combat the financial implications of the pandemic. In March 2020, the Fed announced it would keep its federal funds rate between 0% and 0.25%. It also announced plans to purchase at least $500 billion of Treasury securities over the coming months.

As the Fed continued to promote economic growth, the United States emerged from the pandemic. After peaking at 14.8% in April 2020, the nation’s unemployment rate dropped to 6.1% just 12 months later. After falling for two consecutive quarters, gross domestic product (GDP) increased starting Q3 2020.

However, in exchange for promoting economic growth during this period, the nation began to experience price instability. In May 2020, the 12-month percentage change in the 澳洲幸运5官方开奖结果体彩网:Consumer Price Index was 0.1%. This rate grew to 9.1% in June 2022. The nation had successfully navigated the economic downturn, but the growth in the nation’s money supply had caused inflation. As of December 2024, inflation rests at 2.9%.

The Bottom Line

When the Federal Reserve increases the money supply, 🧔inflation may occur. More often than not, if the Fed is attempting to stimulate the economy by growing the money supply, prices will increase, the cost of goods will be unstable, and inflation will likely occur.