Causes of Inflation
There are 3 causes of inflation:
1.Economic growth: When GDP goes up, C goes up, G goes up, I goes up, Aggregate demand goes up, prices goes up, inflation goes up
2. Monetary policy(money supply/interest rates):
a. Interest rate goes down ==> more loans ==> Investment spending goes up ==> Consumption spending to go up(when I / C goes up) ==> agreggate demand to go up ==> prices to go up ==> inflation to go up
b. i. if we print more money this means more cash chasing the same number of goods and services and it will cause the prices to go up.
bii. Increase money supply: the money in circulation will make people to lend out money, because many people are willing to lend, it will cause the interest rate to go down and i goes down ==> more loans ==>increase in spending ==> Aggregate demand to go up ==> prices to go up.
3. Increase in employment(decrease in unemployment rate): is explained better by the philip curve. it states that there is an inverse relationship between unemployment and inflation. Unemployment rate goes down ==> less potential workers ==> wages goes up ==> cost of production goes up ==> aggregate supply to go down ==> prices to go up(when prices goes up) ==> interest rate to go up ==> less loan ==> C/I spending to go down ==> Aggregate demand to go down and prices will go down.Prices down ==> interest rate to go down ==> more loans ==> C/I to go up ==> agregate demand to go up ==> prices to go up. we get into business cycle because of this relationship.
Dr. Stephanie powers, Introduction to Business Macroeconomics - Economic growth page 25-27, Donald school of Business, Winter 2012.