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Why does inflation not follow the money supply?


The title is a question which appeared in the Quora knowledge platform on 10 April 2021, and it was answered by Gia Wang as follows:

If inflation followed the money supply then this would amount to assuming that everyone (individual, business and government) just spends all their money into the real economy. No savings, no investment in the capital market, no buying houses (the prices of houses are not included in the CPI calculation, but rent is included)

And even if everyone spent all of their money into the real economy, why would any seller necessarily increase their prices? In fact, we observe that, in order to compete with other similar sellers of products, businesses offer discounts all the time.

So, what is it that really makes a business increase the prices of its products? The answer is (a) restrictions on production, and (b) the cost of production. When a business can’t manufacture enough products to meet the demand, they raise prices to maximize their revenue. Or alternatively when the production cost increases, they have to raise prices in order to cover what would otherwise be losses.

All in all, the real cause of inflation lies mainly with production problems, rather than with the money supply.

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