If inflation is caused by there being more money to comparison to goods, if you increased production of goods to match the pre-inflation ratios of money to goods, would you effectively solve inflation?

  • 2
    $\begingroup$ What do you mean by "solve inflation"? $\endgroup$ – Giskard Aug 31 '20 at 18:59
  • $\begingroup$ @Giskard balance it out $\endgroup$ – Sean Taylor Sep 1 '20 at 2:14
  • $\begingroup$ What do you mean by "balance it out"? Make inflation zero? $\endgroup$ – Giskard Sep 1 '20 at 5:40
  • $\begingroup$ Also who's "you"? There is no person on earth who can force the economy to make more stuff. Not even the President of the USA. $\endgroup$ – user253751 Sep 1 '20 at 8:46

I am not sure how you want to solve inflation but i assume you want to know if production could be connected with the overall price level in the economy.

Lets take a look at the eqaution of exchange:

$ M \cdot V = P \cdot T$

Wher M equals money supply, V the velocity of money (how often was one unit of money used), P the price level and T a number for aggregate transactions. However number of transaction are correlated with the goods produced in the economy. We can thus write the income version of the equation as:

$ M \cdot V = P \cdot Y$

Dividing by Y verifies your assumption. Given that money supply and circulation speed are constant, higher production decreases the price level in the economy.

$ \frac{M \cdot V}{Y} = P$

  • $\begingroup$ Velocity is certainly not a constant. This can be validated by looking at time series data. $\endgroup$ – Brian Romanchuk Sep 1 '20 at 1:23
  • $\begingroup$ @Armenthus if there are more transactions wouldn't the velocity of money also be greater? $\endgroup$ – Sean Taylor Sep 1 '20 at 2:07
  • $\begingroup$ @BrianRomanchuk I did not claim that the velocity of money is constant per se. In fact, none of these variables are constant. I tried to make a ceteris paribus consideration. This helps us to identify the influence of Y in this equation. One could also assume that the velocity is growing over time and Y grows over-proportional. This leads to the same result: An increase in Y (in relation to the other variables) does tend to reduce the overall price level in the economy. $\endgroup$ – Armenthus Sep 1 '20 at 6:32
  • $\begingroup$ @SeanTaylor Please read my answer and the equations carefully. I just explained the first case in which this is not true: V and M can be constant if the price level P decreases. If prices decrease, the velocity (how often was one unit of money used) stays constant even if transactions (i.e. Y) rise. $\endgroup$ – Armenthus Sep 1 '20 at 6:38
  • $\begingroup$ @Arementhus, you wrote “Given that money supply and circulation speed are constant”, saying “ I did not claim that the velocity of money is constant per se” makes little sense. $\endgroup$ – Brian Romanchuk Sep 1 '20 at 19:28

In the real world, the answer is that anything can happen.

  • If the inflation is associated with a shortage of a key good - e.g., oil supply squeezes by OPEC in the 1970s, or raw food prices for countries with a low weight of processed food in the CPI - bringing more supply in will lower prices.
  • However, countries can grow in real terms and inflation rise, as seen in the U.S. in the 1970s: link to FRED database.

The reason for the indeterminacy is straightforward. New output does not magically appear. Workers need to be hired, and quite often there is fixed investment needed for new productive capacity. That hiring and/or fixed investment can make supply bottlenecks worse.

However, the question’s focus on the money supply is not helpful. The velocity of money is unstable, and so one cannot draw any useful conclusions between monetary aggregate growth and inflation on any reasonable forecast horizon. M1 velocity in the United States.


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