Question

If someone argues that increasing money supply is the only factor that causes inflation, do you agree with this argument? If yes, please explain how money supply results in inflation. If no, what are other factors that can result in inflation? And how do they influence inflation?

Answer 1

No, money supply is not the sole factor which leads to inflation but yes money supply is one of the factor that leads to inflation. Rise in money supply raise cash holdings with people which tends to raise willingness to pay by consumers which raise aggregate demand in the economy. Rise in aggregate demand raises the price level as well as output level which result in rising inflation.

Other factors that leads to inflation:

• Expansionary fiscal policy which reduce tax rate and leave more disposable income with consumers to spend on goods will raise aggregate demand and raise inflation.
• Supply side factor of inflation rate: It occurs when there is rise in cost of production of goods which reduce aggregate supply of goods and raise price level.