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Monetary theory
Inflation
221
222
Monetary theory
demand for goods, can thus coexist with recession, usually attributed to an
excess demand for money and an excess supply of goods. Stagflation exhibits
the consequences of both excessive and deficient growth in the quantity of
money, the excess occurring earlier and the deficiency currently. The earlier
excessive growth establishes an inflationary momentum that now keeps eroding
the real value of the money supply, which is no longer growing so fast. (Pages
2314 below elaborate on inflationary momentum.) Against a background of
too much spending earlier, spending becomes deficient in real terms now and
output falls. This diagnosis does not necessarily recommend, however, revving
up money again. It also illustrates that one need not resort to supply shocks in
order to explain stagflation. On page 237 below we argue that this analysis can
account for stagflation in the United States during the mid-1970s.
What causes the monetary expansion that fuels inflation? No one answer
always applies: different causes have operated in different historical episodes.
Saying this is no mere lame eclecticism. It corresponds to the way things are.
As an expository device the distinction is far from sharp we may classify the
causes or sources of monetary expansion under two headings. First are factors
exogenous to the process of setting wages and prices. Money growth is cause
rather than consequence. Second are ways in which money growth accommodates nonmonetary upward pressures on prices and wages instead of occurring
independently. Several different circumstances belong under each heading.
Inflation
223
224
Monetary theory