How does the money supply affect inflation?

Increasing the money supply faster than the growth in real output will cause inflation. The reason is that there is more money chasing the same number of goods. Therefore, the increase in monetary demand causes firms to put up prices.

How does reducing money supply decrease inflation?

One popular method of controlling inflation is through a contractionary monetary policy. The goal of a contractionary policy is to reduce the money supply within an economy by decreasing bond prices and increasing interest rates. So spending drops, prices drop and inflation slows.

What is money supply inflation?

Monetary inflation is a sustained increase in the money supply of a country (or currency area). However, there is a general consensus on the importance and responsibility of central banks and monetary authorities in setting public expectations of price inflation and in trying to control it.

What is the relationship between inflation and money supply?

Inflation, or the rate at which the average price of goods or services increases over time, can also be affected by factors beyond the money supply. The theory most discussed when looking at the link between inflation and money supply is the quantity theory of money (QTM), but there are other theories that challenge it.

How does inflation happen?

Inflation can happen if the 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 serves increases over time, can also be affected by factors beyond money supply.

What is the quantity theory of inflation?

A more nuanced version of the quantity theory adds two caveats: New money has to actually circulate in the economy to cause inflation. Inflation is relative—not absolute. In other words, prices tend to be higher than they otherwise would have been if more dollar bills are involved in economic transactions.

What is cost-push inflation?

Cost-push inflation occurs when the input prices for goods tend to rise, possibly because of a larger money supply, at a rate faster than consumer preferences change. Investopedia requires writers to use primary sources to support their work.