Although, as we saw in the previous sections, there is still a debate among theorists about whether money affects the economy or money is neutral (or even superneutral), the reality of the modern world convincingly demonstrates a variety of monetary phenomena that provide the most direct and a profound impact on people's well-being. Monetary problems of the modern economy include inflation, financial crises, problems of economic growth. Issues related to the functioning of money in an open economy will be put in a separate part due to their special complexity and versatility.


Repenting well, but not doing evil - even better.

Gustave Flaubert,

The French writer of XIX century.


• to study the mechanism of the emergence of inflationary processes in modern economies;

• analyze the role of the state in the emergence and preservation of inflation;

• Evaluate the role of expectations in the formation of the inflation mechanism;

• Investigate the anti-inflationary policy of the state;

• Understand the role of inflation in economic growth.

After studying this chapter, the student must:


• features of inflation of different kinds;

be able to

• analyze the costs and benefits of inflation in the short and long terms;

own skills

• Researching the causes and consequences of the anti-and pro-inflationary policies of monetary authorities.

Question for reflection

If inflation causes such serious harm to the well-being of citizens of the country, why do governments of all countries without exception resort to this tool?

Inflation as an economic phenomenon

Probably, there is no other phenomenon of the economic world that would cause so many disputes and disagreements among professional economists, and among the most ordinary citizens, as an inflation problem. What is inflation? What are the roots of the inflationary mechanism? Is inflation connected solely with monetary factors, or is there a combination of a variety of economic and non-economic events? This is the range of issues discussed in this chapter.

The concept of inflation

Inflation is a systematic rise in prices in the economy.

Not any increase in prices can be called inflation. When there is a simultaneous growth of aggregate demand in the economy or a reduction of the aggregate supply, this causes an adaptive reaction of the economy in the form of a rise in price parameters. However, after the process of adaptation has come to an end and the prices have shifted upward to a certain, the same value, leaving the cost proportions practically unchanged, further price increases have occurred. Here we are dealing not with inflation, but with the mechanism of economic adaptation.

Inflation is a long-term phenomenon. This is always a monetary phenomenon: in order for inflation to appear, necessary and sufficient conditions are an increase in the money supply in circulation.

Whatever the initial impulse of price growth, prices can increase once and be maintained further on a new level, without changing. Inflation will not. There will be just an ordinary market price adjustment. We talk about inflation only when prices in the economy continue to grow from month to month, from year to year, even if the very first push has already ended. What makes prices move up in this case?

Recall the Fisher equation:

Now we are interested in prices ( P ). In equilibrium, the demand for money equals the supply of money, i.е. under M can be understood the entire available money mass, without making a difference, demand it or offer. If it is necessary to trace the changes in these quantities, use another form of the Fisher equation:

where small letters denote the rates of growth or decline, expressed as a percentage of the original value: t - the rate of growth in the money supply; v - the rate of change in the speed of money; π - rate of inflation; y - the rate of change in output.

From where you can express the rate of inflation: π = t + v - . The volume of production and the speed of circulation vary very slowly. For a short period of time, the rate of change is inconspicuous and may well be equated to zero: v = 0 and y = 0. Then the rate of inflation will be equal to the rate of change in the money supply in the economy: π = t. The more money is printed in the economy, the higher inflation will be. Therefore, they say that inflation is an exclusively monetary phenomenon: do not print a lot of money and there will not be a price increase!

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