The Theory of Inflation and the Critique of Monetary Theory

Abstract

Friedman’s monetary theory suggests that the supply of money is constantly equal to the demand of money. Therefore, it cannot justify that inflation is indeed caused by over issuance of money. The root cause of inflation should be the short supply of a basket of goods. The weight of each goods in this basket is based on their scarcity in the actual supply and demand environment. The over issuance of money by the government is only one of the many reasons behind the short supply of a basket of goods. Since more money has been pumped into the circulation, the amount of goods in the basket becomes smaller in relative terms, hence the short supply. Actually, over issuance of money, as well as short supply of raw materials, labor, and products all contribute to the potential occurrence of inflation. One should not simply attribute all inflation phenomenon to the over issuance of money. The nature of money is credit. Therefore, as long as the reserve and trading part of the money’s creditworthiness is acceptable by the market, there should be no directly linkage between inflation and amount of money in the circulation.