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What Causes Inflation

Before we can discuss the causes of inflation, we should first understand exactly what inflation is. According to Webster's Collegiate Dictionary, inflation is defined as an increase in the volume of money and credit relative to available goods, resulting in a substantial and continuing rise in the general price level.

So what does this really mean?

Essentially, inflation represents an increase in the average price of goods and services. Money loses purchasing power, since the same amount buys progressively less of the same items or services during inflationary periods.

So what causes inflation?

While there are various factors that contribute to inflation, the prevailing view is that the primary cause of inflation is the growth of the money supply. When more money is available than needed, consumers and businesses try to purchase more goods and services than can be produced. Prices surge and each dollar's purchasing power is less than before.

Shocks to the economy can also trigger short-term periods of inflation; current examples include fluctuations in oil prices and the cost of certain food items, like milk.

Next, let's explore the relationship between inflation and interest rates.


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