1

Mohammad Rayyan Ahmed

Quiz 3

“Inflation is always and everywhere a monetary phenomenon.”

-Milton Friedman

What is inflation? The simplest possible explanation, that even a layman would
understand, would be that it shows how much the prices of items have increased over the
time. Of course, when we get into the finer details, we will find that inflation is not studied in
relation to any individual item, but it is studied on a larger scale, it is an economy-wide
concern. Thus, we cannot use just simple tools, or some random items off the racks of your
local grocery store. Certain measures such as CPI and GDP Deflator are used to measure the
price levels, and the health of the economy in general, and then from this data we move onto
measuring the inflation rate of the economy.

Having established the basics of Inflation, it is important to go in depth, and

emphasize on some previously stated facts about the monetary phenomenon. Even in the
simplest of definitions, we use the term price to describe the effect of inflation, we do not say
that the demand of certain item increased, or that the purchasing power of the individuals in
the country has changed, thus resulting in an increase in the prices. We talk about the prices,
because inflation has to do with the value of money. It is the money that is losing value, not
the item that is gaining value. The increasing price levels of different items, or of a basket of
good, means that the value of money over time is decreasing. That is inflation.

Much like the pandemic, the inflation has no conscience, it does not see who gets
hurt, it affects everybody living in the country. How adverse the affect on the individual
depends on the standard of living of the individual themselves. Now, before we go on to
“cancel” inflation, we must realize who is controlling the strings of this whole production.
We, people, do. The decisions that the people in power make, and the actions they take. Now,
this begs an intriguing question: what, or who, controls the value of money?

The answer: supply and demand. Like all other things in the economy, the value of
money is driven by the supply and demand of the money. The supply is the controlled by the
state, a federal body will regulate the flow of cash throughout the system (country). To keep
things simple, we will just say that the banking system, and the Federal reserve work together
to maintain an adequate supply of money, this is done by loaning out money, and selling
bonds among other instruments they use to ensure an equilibrium. The demand of money is
 2
Mohammad Rayyan Ahmed

basically the amount of money an individual wants to hold in their hand in liquid form, that is
cash. When an individual receives their paycheck, they have a very important decision to
make, because money plays an important part of our lives, and it is our responsibility to
invest or spend it smartly. We can either keep it in liquid form in our wallets to use, we can
invest it in a stock, or bond that gives us a good return on our investment, or we can put it in a
savings account. Now, what drives whatever decision we make? The economy. If the prices
of goods have increased, then we must keep it in our wallets, if the economy is stable then we
can invest it in our favorite stocks and diversify our portfolios. This relationship between
price levels, and the supply-demand of money is a tricky one, it goes both ways.

If the value of money goes above or below the given equilibrium value, then the
supply-demand curve of money shifts. Now that we have established the effect of the average
price level on the equilibrium value of money, we must discuss the other direction of this
transactional relationship. The effect of the quantity of money, or a shift in the supply of the
money, on the average price levels of the country. A graphical depiction of this scenario
would show that the supply of money is a vertical line, it is a set amount of money by the
state that is allowed into the market. If the state were to respond to an increase in the demand
of money by injecting more money into the market, this would shift the supply curve to the
right, and the result in the value of money decreasing. A decrease in the value of money, in
turn means an increase in the price level.

I refer back to a saying of the renowned economist Milton Friedman, “Inflation is

always and everywhere a monetary phenomenon.” Increasing the quantity of money in the
economy, decreased the value of the money, increased the price level, and resulted in what
we have already established is called inflation. So, what holds a major stake in the cause of
inflation? Money. Money is the cause, not the solution.