If the money supply continues to expand what does that eventually imply about inflation?

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pohnpei397 | College Teacher | (Level 3) Distinguished Educator

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Since you have tagged this with “quantitative easing” and have been asking about that process in recent questions, I will answer in that context.

The process of quantitative easing involves the Federal Reserve buying government securities from the banks that hold them.  It does this even though the interest rate is near to zero.  When it buys these securities, it does so using money that had not previously existed.  This is why some people say that this process is akin to having the Fed “print money.”

This process is meant to expand the money supply.  However, when the money supply expands, inflation becomes a possibility.  This is because an increase in the money supply implies that aggregate demand will increase.  One way that demand can rise is if consumers have more money to spend.  If they do, they will be able to afford to spend more on the same goods.  This will cause prices to rise.  This sort of inflation is called “demand-pull inflation” because it is caused by increased demand.

Thus, an increased money supply can lead to an increase in inflation.  It does so because the increase in the money supply allows consumers and businesses to pay higher prices for goods and services than they could when the money supply was smaller.

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