Okay, so with the gold standard we have a certain amount of gold and a certain amount of printed money. If we start printing more money but our gold reserve stays the same, our printed money devalues and inflation rises. But now after we have no gold standard, in relation to what do we measure the value of the money and what causes inflation to go up?
What causes inflation in fiat currency?
byu/viktor2802 inAskEconomics
Posted by viktor2802
6 Comments
Inflation has nothing to do with currency value against gold reserves. Inflation is the measure of the general increase in the prices of goods and services. There is no other definition of inflation.
What influences inflation is a pretty complicated topic without simple one line answers. Very broadly speaking, in monetarist theory, inflation is linked to the amount of money in the economy. But this is just one perspective. There are two types of inflation in basic economic theory – demand pull and cost push. (bear in mind they can both be in effect at varying levels at the same time)
In very simple terms, demand pull inflation is too much money (demand) chasing too few goods. Cost push inflation is shocks to the supply chain increasing the cost of producing goods.
If there is the same about of stuff to buy and the same amount of services available to hire tomorrow as there is today, but tomorrow, magically, there were twice as many dollars in circulation then the price of everything would double. You don’t need a reference to the value of any one particular thing. It works exactly the same way it does when comparing to the price of gold; if there’s more money and the same amount of gold, then each dollar buys less gold. If there’s more money but the same amount of everything, then each dollar buys less of everything.
Economists measure the value of money in relation to goods that households buy. We price out the same “shopping cart”, year after year.
Inflation happens when too much money is created. With the gold standard, inflation occurred with the discover of new gold and silver. With fiat currency, inflation occurs when the government prints too much money.
The amount of money goes up while productivity remains the same.
Or the amount of productivity goes down while the amount of money remains the same.
I think we’ve got some of the way to an answer here.
It’s useful to talk about the Cambridge equation here which is generally written these days as: `MV=PQ`.
The left hand side of it represents monetary spending. There is the money supply `M` multiplied by the “velocity” `V`. That V is more accurately a rate-of-turnover. It represents how often each monetary unit is used on average. As people and businesses hold more money V decreases as they spend down their holdings of money V increases.
The other side of the equation represents nominal GDP. There is `Q` the quantity of goods and services transacted – a vector. Then there is `P` the price of goods and services – also a vector. There is a price each for every good in Q.
To put it another way, you could rewrite it without vectors as:
MV = P1Q1 + P2Q2 + …
Where Q1 represents the first good, Q2 the second good and so on. Inflation is the rise in the prices, the Ps.
There are several ways that can happen. Either M or V can rise. That is there can be a rise in the supply of money, or a rise in the rate of turnover of money. The third possibility is that Q decreases, that is there is a recession and the amount produced falls while M and V stay the same.
Inflation isn’t linked to the amount of money that exists, but rather the amount of money being spent.
If more is being spent than is being produced, for a duration of time, then prices rise.
This can happen because less things are getting produced (because of a pandemic, or a war, or electricity prices go up, or a winter is very harsh).
It can also happen because people are optimistic, and spending more, or taking out loans, or spending down savings, or buying goods on credit, or their wages have gone up – all of which is made easier if more money exists, but it’s not a 1:1 relationship