Causes and consequences of inflation

Abstract

Inflation is a persistent general increase in the price level of all goods and services. It is a situation where aggregate demand for all goods and services exceeds aggregate supply in a given economy. Such disequilibrium can be temporarily caused by a number of factors that affect either the demand side or supply side of the economy. The persistency of inflation, however, can be explained only by a continuous increase in total money supply. The current study looks into the causes of inflation as explained by different economic schools. First of all, the possible causes and economic and social effects of inflation are identified. Next, the theory of money and inflation is described from the viewpoint of different economic schools. The last part carries out an empirical study to test the monetarists' argument that excessive money supply leads to inflation. The study uses Grangers causality test to see the direction of causality between money supply and inflation in selected countries. The results of the test, for nine countries, seem to support the monetarists' argument that excessive money supply leads to inflation. In addition, the results show that the time it takes for additional money supply to translate into inflation varies among the countries studied.