At one time, economists classified inflation into two types: (1) demand-pull inflation is generated by excess demand for goods and services pulling up prices, and (2) cost-push inflation is generated by higher costs such as energy price increases imposed by an oil cartel or wage increases demanded by powerful labor unions being passed on in higher prices by monopoly firms. Currently this classification is seldom used, except in classifying short-run forces affecting prices. In the long run, neither type of inflation can be sustained without an accommodating growth in the money supply.
If the central bank does not accommodate demand-pull and cost-push price increases with accompanying increases in the money supply, the demand for money grows faster than the supply of money. The resulting excess demand for money pushes up the interest rate and decreases aggregate demand for goods and services, killing the inflationary forces. Consequently, economists have come to view the cause of inflation as excessive money-supply growth, agreeing with the monetarist view that in the long run inflation is always and everywhere a monetary phenomenon.
Surely, though, the real cause of inflation is what is causing the central bank to increase the money supply at an excessive rate! The purpose of this chapter is to consolidate material from earlier chapters that lend insight to this issue.
