Can some body tell me what causes inflation?

I understand the effects of inflation, but where does the extra moeny come from if our the worldscurrency is continously worth less. Does the govenment print extra money, or is it gold mining that brings more money in to the economy?

Thanks for your time.

Inflation occurs when aggregate demand increases faster than aggregate supply. Thus, inflation can be triggered by either an increase in aggregate demand or a decrease in aggregate supply.

Due to constant increases in technology and efficiency, human productivity has continuously increased over the last 200 years. As humans become more productive, the average income per human increases. As humans realize more disposable income, they will in turn demand more goods and services. This creates the increase in aggregate demand. As more and more consumers demand goods and services, the providers of those goods and services can charge a higher price, resulting in inflation.

Aggregate demand can also be increased with a loose monetary or fiscal policy. By lowering interest rates, the Federal Reserve discourages saving and encourages spending and investment in new production, increasing the average income of Americans. Likewise, the Federal government generally spends more than it collects in taxes. This excess is often "loaned" by the Federal reserve with newly printed money, putting more dollars in the hands of taxpayers than they paid in taxes. Again, the result is an increase in aggregate demand.

On the other hand, a supply shock such as a shortage of a crucial natural resourse can dramatically increase the cost of providing goods on services on a large scale. This results in a decrease in aggregate supply. Consumers essentially bid against each other for increasingly scarce goods and services. Suppliers must increase the price in order to remain profitable in the face of increased production costs, and the scarcity of their good or service allows them to. Again, the result is inflation.

Inflation, aggregate demand, and aggregate supply often have a spiralling effect on each other. Higher prices leads to more money in the hands of producers, who in turn have more money to spend, adding to the increase in aggregate demand. Likewise, higher prices will cause employees to demand more money from their employers, increasing the costs of production and thereby reducing aggregate supply. This is why the Federal Reserve keeps close tabs on inflation in order to prevent this spiral from getting out of control.

Actually, you are on the right track. Inflation is not an increase in prices (that's the effect). The cause of inflation is the increase or inflation of the money supply.

Yes, supply & demand does affect prices, but the primary cause is money supply.

Our money used to be backed by gold and silver. When that was the cause, supply & demand greatly affected price fluctuations. Prices fluctuated up and down depending on whether the consumer or producer had the bulk of the money. If the consumers had the bulk of the money, prices would go up as they had the money to demand goods. If producers had the money, the prices went down as they had the supply and money, so consumers had nothing to spend. Although prices fluctuated, inflation was net ZERO. When our currency was backed by gold and silver, you could only print the amount of money you had in gold and silver reserves. In other words, if you had $400 billion in gold and $38 billion in silver, you could only print $400 billion in gold certificates and $38 billion in silver certificates as they can be redeemed for the gold or silver in the reserves.

As of 1971, the U.S. dollar is no longer backed by gold or silver. Nixon closed the gold window when France tried to redeem it's huge reserve of gold certificates. Nixon didn't want to give France our gold, so he closed the gold window. As of now, there is not country that I know of that backs its currency with gold or any other precious metal. All the currencies are pure fiat (meaning "by decree"). The dollar is only backed by the good faith and credit of the government.

The problem is, when you have no asset backing your currency, you can print money at will, and printing money is what drives inflation.

Here's an example; let's say you have a widget to sell and I want to buy your widget. You are selling that widget for $1 because you need $1 in purchasing power to meet your needs. I have $1 and let's say that that $1 is indeed worth $1. So, the price of the widget therefore is $1. But, let's say times passes and the government starts printing money. The more money it prints, the less valuable that money becomes and it loses it's purchasing power. So, the government has printed so much money that that $1 now only has the purchasing power of 25 cents. You have the widget for sale, but you still need $1 in purchasing power to meet your needs. But, since that $1 now only has the purchasing power of 25 cents and you need $1 in purchasing power to meet your needs, you must therefore sell the widget to me for $4 to get $1 in purchasing power.

Do you see what just happened? The price of the widget didn't really go up, it was still worth "$1", but because the purchasing power of the $1 went down, you needed more $$$ to get the same widget, but it looks like the value of the widget went up.

Many of the above posters don't remember their history. Do a web search on the Hyperinflation that occurred in Germany after WW1 during the Weimar Republic. When Germany lost the war, the allies made Germany make war reparations. The problem was the Germany industrial infrastructure has been greatly damanged during the war and thus Germany couldn't produce the goods needed to sell to raise the money to make those war reparations. What they did instead was fire up the printing presses and printed the money they needed. The problem was that printing money drives inflation. They printed so much money that they HYPERinflated the German economy. Prior to doing this, the German Mark trade about 4 or 5 : 1 against the U.S. dollar. By the time the hyperinflation peaked, the mark was trading at 2.4 trillion to 1 against the dollar. It literally took a wheelbarrow full of marks to buy a loaf of bread. My old bosses family owned a restaurant chain in Germany during that time. He said that a simple sandwich was 550,000 marks. It was not unusual for people to carry around 10 billion mark notes. To give you another example, just before they started printing the money, 1 oz. of silver was about 12 marks and 1 oz. of gold about 170 marks. By the height of the hyperinflation, 1 oz. of silver was 586 billion marks and 1 oz. of gold was 87 trillion marks.

They had printed so much money, it was absolutely worthless. I remember seeing a picture of a woman kindling the morning fire using Marks. The currency was so worthless, they used it as fuel for their fires.

The reason gold is so valuable and been the money of choice for so long is because it is so rare. All the gold mined throughout all of history would fit into a storage area that measures 55 feet x 55 feet x 55 feet. Think about it, all the gold ever mined through thousands of years of human history would fit into an area the size of a standard tennis court. That's not a lot of gold.

So you are right, what drives inflation is not really supply and demand, but government printing money at will. With no asset like gold to keep the money printing activities in check, the government can print all the money they need and that is what drives inflation.

There is a lot of debate on your question. My favorite answer is given in the first link below by Mike Shedlock on his blog.

More on the topic of investing on my website, the second link below.

Let's make money!

Good luck

Marc

Inflation happens when there is too little demand for a particular good and too much of it around...

Two things are certain in this world, change happens and prices rise.
Change is dependant on Time.
Prices Riseing is dependant on consumerism. More you get, the more you want.

The extra money essentially comes from the world consumers, or more locally, you and me.

As the cost of manufacturing and distrubiting a product increases, because perhaps the materials to make it cost more or higher gas prices add to the delivery costs, and higher labor wages increase the bottom line too, the manufacturer has to raise the price to the retail outlets. And then the retail outlets have to raise their prices to the walk-in consumers (you and me).

You and me eventually feel the squeeze and through our labor unions or other means, negotiate for higher wages. And we may get them. The employer pays the higher wage, but has to find somewhere else to increase the profits in order to pay for the raises. The cycle is endless.

Here is a web site that addresses the question, "why not just print more money?" It's a serious answer. I also think your question is a great question.

http://economics.about.com/cs/money/a/print_money.htm

Inflation just makes the same things cost more. Like milk, cheese, stamps etc. Overinflation would result in stamps costing pounds rather than pence. It's all to do with the cost of living. House prices are a fairly good example, though are more market led than inflation led, though they'll never reduce back down to what they were ten years ago. I hope!

its the exact opposite of what incognitas said

inflation is caused by demand exceeding supply.

so if there is a shortage of something the price goes up (like oil prices at the moment)

where supply exceeds demand (like when stores over stock on items and then slash the price in their sales ) the price comes down (deflation)

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