Inflation
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Inflation
At Aura Solution Company Limited, we recognize inflation as a fundamental economic indicator—an increase in the average price of goods and services, typically measured by the Consumer Price Index (CPI). As prices rise, the purchasing power of money diminishes, meaning each unit of currency buys fewer goods and services. Conversely, deflation represents a decline in these general price levels.Inflation is influenced by various forces—demand-side factors such as fiscal or monetary shifts, supply-side disruptions like energy crises, and market expectations. While rapid inflation can lead to uncertainty, reduced investment, and shortages, moderate inflation can have constructive impacts. It can ease labor market rigidities, empower central banks with flexible monetary tools, and stimulate lending and economic activity. Aura remains committed to navigating these dynamics with insight and precision, helping clients protect and grow their wealth in all economic environments.
At Aura Solution Company Limited, we align with the prevailing economic consensus that a low and stable rate of inflation is essential for sustained growth and resilience. Unlike zero or negative inflation, a modest rate helps economies absorb shocks by allowing wages and prices to adjust more fluidly during downturns. This, in turn, lowers the risk of deep recessions and mitigates the danger of falling into a liquidity trap—where monetary policy becomes ineffective. Maintaining this delicate balance is primarily the responsibility of central banks. Through tools like interest rate adjustments and open market operations, they work to preserve price stability and economic momentum. At Aura, we monitor these dynamics closely, helping clients stay ahead in a changing economic landscape.
What is Inflation?
Inflation is the sustained increase in the general price level of goods and services in an economy over time, leading to a decrease in the purchasing power of a currency. Simply put, when inflation rises, each unit of money buys fewer goods and services than before.
How Inflation Impacts the Economy
Inflation affects various sectors and groups differently:
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Beneficiaries of Inflation:
Those who own tangible assets like real estate, stocks, or commodities typically benefit. As prices rise, the value of their holdings increases, enhancing their wealth. -
Those Negatively Impacted:
People with fixed incomes, such as pensioners or salaried workers without inflation-linked raises, suffer because their income's purchasing power diminishes. Similarly, cash holders experience a decline in real wealth since money loses value during inflation. -
Debtors:
Individuals or institutions with fixed-rate loans gain, because the real value of their debt decreases. For example, if inflation is 3% and your loan interest is 5%, your real interest rate is effectively about 2%. However, lenders adjust by charging inflation risk premiums or offering adjustable rates.
Negative Effects of Inflation
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Price Distortions and Inefficiencies:
High or unpredictable inflation disrupts market signals. Businesses face challenges in planning, budgeting, and long-term investment, potentially slowing productivity and growth. -
Redistribution of Wealth:
Inflation often shifts purchasing power from those on fixed incomes to those with variable incomes or asset ownership. Internationally, countries with higher inflation may see their exports become less competitive, affecting trade balances. -
Hoarding and Shortages:
People tend to buy and stockpile durable goods to protect wealth against devaluation, which can lead to supply shortages. -
Social Unrest:
Inflation, especially when it causes food price surges, has historically triggered protests and revolutions. The 2010-2011 uprisings in Tunisia and Egypt are stark examples, where inflation-induced hardship was a major contributing factor. -
Hyperinflation:
When inflation spirals out of control, people may abandon the national currency entirely, opting for foreign currencies (a process called dollarization), which destabilizes the economy further. -
Corruption and Economic Distrust:
Inflation can erode trust in financial institutions and governments, leading to increased unemployment and economic volatility, harming long-term growth and investment. -
Shoe Leather and Menu Costs:
Individuals and firms face increased transaction costs due to frequent bank visits ("shoe leather costs") and the need to continually update prices ("menu costs"), both reducing economic efficiency. -
Hidden Taxes:
Inflation effectively acts as a tax on money holdings, reducing the real value of savings.
Positive Aspects of Inflation
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Labor Market Flexibility:
Inflation allows real wages to adjust downward even if nominal wages are sticky, helping labor markets reach equilibrium faster and potentially reducing unemployment. -
Monetary Policy Flexibility:
Moderate inflation gives central banks room to adjust interest rates to stimulate or cool the economy. In a zero-lower-bound scenario (when rates are near zero), having some inflation helps avoid economic stagnation. -
Investment Incentives (Mundell–Tobin Effect):
Moderate inflation encourages savers to invest rather than hold money, leading to higher capital formation and economic growth. -
Avoiding Deflationary Traps:
Deflation can cause hoarding and economic stagnation. Moderate inflation prevents deflation, maintaining healthy demand and investment flows. -
Cost-of-Living Adjustments (COLAs):
Many wages and pensions are adjusted for inflation, preserving purchasing power for fixed-income groups. This mechanism helps mitigate some negative effects of inflation.
Summary by Aura
Inflation is a complex economic force with multifaceted impacts. While moderate inflation can support growth, flexibility, and investment, high or volatile inflation can destabilize economies, reduce living standards, and trigger social unrest. Effective policy management and inflation indexing are critical tools to balance these effects and maintain economic stability.
History
Inflation—defined as the sustained rise in the general price level of goods and services—has been a defining feature of economic systems since the inception of money itself. As early as 330 BC, during the reign of Alexander the Great, the world witnessed one of the first recorded episodes of inflation, rooted in rapid expansions of currency and state spending. From ancient empires to modern economies, inflation has both shaped and reflected the socio-economic tides of history.
In economies based on commodity money such as gold or silver, inflation and deflation cycles were often linked to economic shocks or surges in supply. For instance, the 16th-century "Price Revolution" in Europe was triggered by massive infusions of precious metals—particularly silver—imported from the New World. Such inflows increased money supply dramatically and drove up prices across the continent.
The adoption of fiat currency in the 18th century marked a turning point. Unlike commodity-based systems, fiat money isn't backed by physical assets but by government decree, enabling greater flexibility—and volatility—in money supply. This flexibility led to episodes of hyperinflation, especially during times of political and economic turmoil. Notable examples include post-World War I Germany, where the Weimar Republic’s paper mark lost nearly all value, and Venezuela in the 2010s, where inflation soared to an unprecedented 833,997% annually in 2018.
Historically, governments have often manipulated currency to extend resources. Ancient Rome’s emperors, for example, debased silver coins by diluting them with cheaper metals. Under Emperor Nero, the silver content of the Roman denarius fell steadily, resulting in rampant inflation during the Crisis of the Third Century. Similarly, in ancient China, the Song and Yuan dynasties printed paper currency to finance wars, leading to inflation that prompted the later Ming dynasty to revert to copper coinage.
In Africa, the famed Malian emperor Mansa Musa, during his pilgrimage to Mecca in 1324, spent so much gold in Cairo that it devalued the precious metal for more than a decade—an extraordinary example of inflation caused by wealth redistribution rather than currency manipulation.
In Europe, from the late 1400s to the early 1600s, a dramatic inflationary era unfolded. Dubbed the "Price Revolution," this period saw a sixfold increase in prices over 150 years, primarily driven by the influx of New World silver and a resurgence in population after the Black Death. By contrast, since the 1980s, many advanced economies have embraced independent central banking systems with a mandate to maintain low and stable inflation. This monetary discipline ushered in the Great Moderation—an era characterized by reduced macroeconomic volatility, smoother business cycles, and improved economic predictability.
At Aura Solution Company Limited, we emphasize the critical importance of understanding inflation’s complex origins and impacts. From ancient empires to modern financial systems, inflation has been both a disruptor and a driver of economic transformation. Today, we continue to monitor global inflation trends closely—leveraging this deep historical insight to protect and grow client wealth in a rapidly evolving financial landscape.
What is Monetary Policy?
Monetary policy refers to the set of actions taken by a nation's monetary authority, usually the central bank, to achieve specific economic objectives. The most common and critical objective is maintaining inflation at a low and stable level, ensuring economic stability, sustainable growth, and employment. This can be done either:
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Directly, through inflation targeting — explicitly setting an inflation rate goal.
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Indirectly, such as pegging a country's currency to a stable, low-inflation currency area.
Historical Approaches to Inflation Control
1. Gold Standard Era (Pre-WWI to early 20th century)
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The gold standard linked currencies to fixed amounts of gold.
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It ensured a predictable money supply but proved detrimental during economic shocks, such as the Great Depression (1930s), due to its inflexibility.
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Economic growth and employment were hard to stabilize under this rigid system.
2. Bretton Woods System (Post-WWII to 1970s)
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Created a fixed exchange rate system tying most major currencies to the US dollar.
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The US dollar was convertible to gold, creating an indirect gold standard.
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Provided postwar stability but collapsed in the 1970s due to pressures on the US dollar and global imbalances.
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After its collapse, major currencies began floating freely.
3. Monetarist Policies (1970s)
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Influenced by Milton Friedman, these policies targeted controlling the growth rate of money supply to stabilize inflation.
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However, unstable correlations between money supply and inflation made this impractical.
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Most central banks abandoned this in favor of more flexible strategies.
4. Inflation Targeting (1990s to Present)
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New Zealand pioneered official inflation targeting in 1990.
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Central banks adjust interest rates to steer inflation towards a predefined target (usually around 2%-3% in developed economies).
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This strategy balances inflation, output, and employment, and has become the global standard, adopted by all G7 countries and many others.
5. Emerging Markets and Fixed Exchange Rates
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Many emerging economies still use fixed exchange rate regimes to stabilize their currencies and anchor inflation expectations.
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This ties their inflation rates to those of stable foreign currencies but limits their ability to conduct independent monetary policy.
Inflation Targeting Explained
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How it Works: Central banks raise or lower interest rates to influence aggregate demand.
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Higher interest rates cool the economy, reducing inflation.
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Lower interest rates stimulate spending, counteracting deflation or recession.
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The mechanism affects employment and wages — described by the Phillips Curve, showing the inverse relation between unemployment and inflation.
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Most OECD countries aim for inflation around 2%–3%, which is considered ideal to avoid economic stagnation and liquidity traps.
Fixed Exchange Rate Systems
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Countries peg their currency’s value to a stable foreign currency or basket of currencies.
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This strategy stabilizes currency value and inflation if the anchor currency maintains low inflation.
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However, it limits the country’s monetary policy independence — domestic policy must follow the anchor country's inflation and economic conditions.
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Today, among OECD countries, only Denmark maintains a fixed exchange rate (to the Euro).
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Widely used in developing nations to promote stability and investor confidence.
The Gold Standard (Historical Context)
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Currency was directly convertible into a fixed quantity of gold.
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This ensured currency stability but limited monetary flexibility.
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Inflation or deflation depended solely on gold supply growth, which is arbitrary and unpredictable.
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The rigidity contributed to difficulties in managing employment and economic cycles.
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Abandoned globally due to its negative impact on economic stability.
Wage and Price Controls
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Historically used as temporary measures to curb inflation, especially during crises like wars.
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Price controls can slow inflation but often cause market distortions and shortages.
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Wage and price controls combined with rationing succeeded in wartime economies (e.g., WWII).
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Peacetime applications, such as Nixon’s 1972 wage-price freeze, largely failed.
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Some successful cases include Australia’s Prices and Incomes Accord and the Netherlands’ Wassenaar Agreement.
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Generally seen as last-resort or complementary tools, effective only if underlying inflation causes are addressed.
Aura’s Strategic Perspective on Monetary Policy
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At Aura, we understand that monetary policy is a delicate balance between inflation control, economic growth, and employment.
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In today’s interconnected global economy, flexible inflation targeting with transparent communication is the preferred strategy among developed countries.
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For emerging markets, maintaining currency stability through fixed exchange regimes can be necessary but may require careful monitoring to avoid losing monetary autonomy.
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Technological advancements in data analytics and AI can enhance central bank decision-making processes, allowing more dynamic and responsive monetary policy.
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In an era of global uncertainties—geopolitical tensions, supply chain disruptions, and climate risks—monetary authorities must remain vigilant, adaptable, and forward-looking.
Terminology
The term inflation is derived from the Latin word inflāre, meaning “to blow into” or “inflate.” In modern economic terms, inflation refers to the general increase in the price level of goods and services over a period of time, effectively reducing the purchasing power of money. Crucially, inflation is a system-wide phenomenon — it does not refer to a price increase in individual goods due to market demand (such as cucumbers rising in price while tomatoes drop). Instead, it reflects a decrease in the value of money itself, influencing the cost of all goods and services.
Historically, currency tied to gold faced inflation when new gold deposits were discovered, as the supply of gold increased, leading to a decrease in its value, and hence, in the value of currencies pegged to it.
Historical Trajectory of Inflation
Ancient Civilizations & Early Monetary Systems
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330 BC – Alexander the Great’s Empire: One of the first recorded inflationary events occurred following Alexander’s conquest of Persia. The vast plunder introduced large quantities of precious metals into the economy, leading to monetary imbalance.
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Roman Empire (AD 54–270): Under emperors such as Nero, the denarius coin was debased — its silver content was reduced to mint more coins, increasing the money supply. By the 270s, Roman coins held little to no silver, causing rampant inflation.
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Ancient China (Song & Yuan Dynasties): Introduced fiat currency via printed paper money. The Yuan dynasty’s overprinting of notes, especially during wartime expenditures, led to high inflation, prompting the succeeding Ming dynasty to abandon paper money in favor of metal coins.
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14th Century Egypt – Mansa Musa's Gold Flood: The Malian emperor’s generous distribution of gold during his pilgrimage to Mecca caused the value of gold to drop in Cairo, leading to local inflation lasting over a decade.
Medieval & Early Modern Europe
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Price Revolution (15th–17th centuries): Following the influx of silver and gold from the Americas, especially in Spain, prices across Europe rose dramatically. This sixfold price increase over 150 years is attributed to monetary expansion and demographic rebound from the Black Death.
Modern Hyperinflation Episodes
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Weimar Republic (1920s): Post-WWI Germany printed excessive money to pay reparations, causing hyperinflation so severe that citizens used wheelbarrows of banknotes for basic goods.
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Hungary (Post-WWII): The largest inflation ever recorded occurred in Hungary after 1945, where prices doubled every 15 hours.
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Venezuela (2018): Annual inflation reached 833,997%, the result of political instability, economic mismanagement, and overprinting of currency.
Classical Economics on Inflation
By the 19th century, economists categorized three drivers of price changes:
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Value/Cost of Production of Goods – Fundamental changes in how goods are produced.
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Price of Money – Tied to commodity currencies like gold or silver, where price changes reflected supply fluctuations.
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Currency Depreciation – Resulting from an oversupply of paper money unbacked by equivalent reserves of precious metals.
During the American Civil War, private banks overissued redeemable notes beyond their metal reserves. This led to the first uses of the term "inflation" to describe currency devaluation — a critical turning point in monetary theory.
Economists like David Hume and David Ricardo discussed this in depth, with Ricardo emphasizing the Quantity Theory of Money: increasing money supply without a corresponding increase in goods leads to inflation.
Sector-specific inflations include:
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Housing inflation – changes in real estate indices.
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Energy inflation – often driven by oil, gas, and geopolitical factors.
Post-1980s Stability – The Great Moderation
From the 1980s onward, countries with independent central banks adopted inflation targeting policies, such as 2% annual inflation goals, to stabilize economies. The result was:
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Reduced macroeconomic volatility
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Smoother business cycles
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Enhanced credibility of monetary authorities
This period, called the Great Moderation, marked a global shift toward central bank transparency and control of inflation expectations.
Aura’s View on Inflation in the 21st Century
At Aura Solution Company Limited, we view inflation as both a macroeconomic indicator and a monetary policy tool. In modern financial environments driven by fiat currencies, digital money, geopolitical shifts, and global trade dynamics, inflation is not just a number — it is a reflection of trust in institutions, sovereign fiscal discipline, and central bank governance.
Aura's proprietary inflation models within the Aura Research Institute incorporate:
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Monetary velocity metrics
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Digital asset influence
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Sustainable resource indexing
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Geopolitical tension variables
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Population growth vs. productive capacity
These tools help our high-net-worth clients, sovereign partners, and institutional allies hedge, forecast, and structure portfolios in both inflationary and deflationary environments.
Final Insight by Aura
"Inflation is inevitable in any economy driven by fiat money. What matters is not whether it exists, but whether it is measured, anticipated, and managed."
— Alex Hartford, PhD | President, Aura Research Institute
Causes
Inflation, the general increase in price levels over time, has long been a subject of economic scrutiny and policy debate. Since the 16th century, thinkers have explored its causes and consequences, producing diverging schools of thought that shaped monetary theory and central banking practices across centuries. At Aura Solution Company Limited, understanding the historical evolution of inflation theory is vital for anticipating macroeconomic shifts and designing global investment strategies.
I. Pre-Keynesian Era (Before 1936)
1. The Quantity Theory of Money (QTM)
The roots of the Quantity Theory of Money date back to the Price Revolution (1550–1700), when rising silver supplies and innovations in financial instruments like bills of exchange drove price levels upward across Europe. Early economists attributed this to increased money supply and debasement of currencies.
Core Equation (QTM):
MV = PQ
Where:
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M = Money supply
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V = Velocity of money
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P = Price level
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Q = Output of the economy
This theory asserts that inflation results when the money supply increases faster than real output, assuming velocity (V) is stable.
2. Real Bills Doctrine (RBD)
Emerging from the works of Adam Smith in The Wealth of Nations, the Real Bills Doctrine proposed a contrasting view:
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Banks should issue money only against short-term commercial debt ("real bills").
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As long as each unit of currency is backed by real value, inflation will not occur.
The doctrine emphasizes credit quality over quantity, asserting that inflation is caused when money exceeds the value of its backing assets, rather than goods.
3. The 19th Century Schools
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Currency School (UK): Advocated strict adherence to gold reserves; aligned with QTM.
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Banking School (UK): Endorsed RBD; currency should follow trade needs.
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Free Banking School: Asserted that market-driven private banks would self-regulate issuance and avoid overexpansion.
These debates prefigured modern discussions on central bank credibility and the efficacy of monetary control.
II. Keynesian Economics (1936–1960s)
1. The General Theory – John Maynard Keynes (1936)
In The General Theory of Employment, Interest and Money, Keynes introduced a new framework:
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Sticky wages and prices delay adjustments, making economies vulnerable to demand shocks.
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Inflation arises primarily due to aggregate demand fluctuations, not money supply.
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Policy tools:
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Fiscal policy (spending and taxation)
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Monetary policy (interest rates)
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2. The Phillips Curve (1958)
Developed by A.W. Phillips, this model demonstrated a short-term inverse relationship between unemployment and inflation:
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Lower unemployment → Higher inflation
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Higher unemployment → Lower inflation
This trade-off informed macroeconomic policy throughout the 1960s, until stagflation in the 1970s challenged its stability.
III. Monetarism (1960s–1980s)
1. Milton Friedman’s Revolution
Friedman reasserted QTM, famously stating:
“Inflation is always and everywhere a monetary phenomenon.”
Key propositions:
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Money supply (M2) is the key driver of inflation.
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Velocity (V) and output (Q) are stable in the long run.
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Fiscal policy is ineffective; monetary policy is dominant.
He introduced the concept of:
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Natural rate of unemployment (NAIRU): the unemployment level consistent with stable inflation.
2. The Long-Run Phillips Curve
Friedman and Edmund Phelps argued the Phillips Curve only holds short term:
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In the long run, expectations adjust.
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Attempting to reduce unemployment below NAIRU through stimulus leads to accelerating inflation, not sustained employment gains.
IV. Rational Expectations & New Classical Economics (1970s–1980s)
1. Rational Expectations Hypothesis (REH)
Developed by Robert Lucas, Thomas Sargent, and Robert Barro:
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Economic agents are forward-looking and form expectations based on anticipated policy.
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Systematic monetary policy becomes ineffective because agents preemptively adjust wages and prices.
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Credibility and consistency become central to central bank policy.
This theory revolutionized policy thinking:
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Credible commitment to low inflation leads to low inflation expectations.
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Reputation of central banks became a central variable in economic modeling.
V. The New Keynesian Synthesis (1980s–2000s)
Following the stagflation crisis and monetarist critique, New Keynesians revised Keynesian theory to incorporate:
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Price and wage rigidities (via contracts and menu costs)
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Forward-looking expectations
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Monetary policy rules (like Taylor Rules)
They accepted that:
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There is no long-run trade-off between inflation and unemployment.
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Inflation targeting and independent central banks are essential for macroeconomic stability.
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The natural rate hypothesis holds: any attempt to push unemployment below its structural level will lead to inflation.
VI. Aura’s Position on Historical Inflation Theory
At Aura Solution Company Limited, our interpretation of inflation theory is integrative and evidence-based:
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Inflation is multifactorial. While money supply plays a crucial role, demand shocks, expectations, supply chain disruptions, and institutional credibility also significantly influence inflation dynamics.
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Credibility is policy. Aura affirms that the credibility of central banks and sovereign institutions is as pivotal as monetary aggregates.
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Expectations management is central. Rational expectations must be actively shaped through transparent, rule-based monetary policy.
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Long-term price stability requires structural insights. Beyond short-term tools, fiscal discipline, real productivity growth, and global supply chain integration are key to inflation containment.
Inflation Since 2000: Detailed Overview
1. Modern View of Inflation Dynamics
Since around the year 2000, economists generally understand inflation as being influenced by multiple factors working together. The Phillips curve, which originally showed a trade-off between unemployment and inflation, has been expanded to include:
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Demand shocks (changes in aggregate demand),
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Supply shocks (changes in aggregate supply or production capacity),
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Inflation expectations (how people expect prices to behave in the future).
This more nuanced view is sometimes called the triangle model (by Robert J. Gordon), which acknowledges that inflation is caused by three interacting forces:
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Demand-pull inflation: Occurs when aggregate demand (consumer spending, investment, government spending) increases faster than aggregate supply, pushing prices up.
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Cost-push inflation: Caused by supply shocks that reduce the economy's output capacity, raising production costs (e.g., oil price spikes, natural disasters), which producers pass on as higher prices.
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Built-in inflation: Inflation that persists due to workers and firms expecting inflation to continue, leading to wage-price spirals.
2. Role of Inflation Expectations
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Inflation expectations influence wage negotiations and price-setting behavior.
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For example, if workers expect prices to rise by 5%, they demand wage increases of 5% or more to maintain their purchasing power.
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Firms, facing higher labor costs, raise prices to maintain profit margins, thus creating a feedback loop.
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This can cause a wage-price spiral — inflation "begets" inflation through expectations.
3. Monetary Policy and Central Banks
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Modern central banks focus on inflation targeting, adjusting interest rates to keep inflation around a set target (e.g., 2%).
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The money supply targeting approach (from monetarist theories) has largely been abandoned because:
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Central banks can control narrow money measures like the monetary base but these are weakly correlated with actual inflation.
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Broader money measures (like M2) are harder to control precisely.
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The relationship between money supply growth and inflation has weakened over recent decades.
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Rational expectations and credibility of central banks are key: if people trust the central bank to maintain low inflation, inflation expectations stay anchored, helping stabilize prices.
4. Empirical Evidence from Surveys
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Since the 1990s, many economists agree that too much growth in the money supply is a primary driver of inflation.
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However, there is less consensus that reductions in unemployment cause higher inflation in the short run (contrasting with the original Phillips curve ideas).
5. Additional Inflation Drivers in the 21st Century
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Housing shortages: Limited housing supply combined with increasing demand can push up housing prices, contributing to overall inflation.
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Climate change: Environmental changes and policies can disrupt supply chains, increase production costs, and affect food and energy prices, indirectly pushing inflation higher.
The 2021–2022 Inflation Spike
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After the COVID-19 pandemic, many countries experienced a sharp rise in inflation.
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Causes were a combination of:
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Demand shocks: Expansionary fiscal stimulus (government spending) and loose monetary policy to support economies.
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Supply shocks: Pandemic-related supply chain disruptions, labor shortages, and energy price hikes (exacerbated by the 2022 Russian invasion of Ukraine).
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Inflation expectations remained relatively stable during this period, indicating people did not expect runaway inflation.
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Sellers’ inflation emerged as a term describing firms leveraging supply constraints and market power to increase prices and profits rather than increase output.
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Oil companies, for example, raised prices quickly when costs rose but reduced prices slowly when costs fell, taking advantage of price inelasticity.
Money Supply and Inflation: Monetarist View vs. Reality
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Libertarian and conservative critics often blame inflation on excessive money supply growth.
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During the pandemic, the M2 money supply grew rapidly, which some linked to inflation.
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However, Fed officials (Jerome Powell, Ben Bernanke, Alan Greenspan) argue that the historical strong link between money supply growth and inflation has weakened due to:
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Financial innovations,
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Deregulation,
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Lower velocity of money (money circulates more slowly),
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Changes in how money supply correlates with demand and prices.
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For example, from 2010–2015, M3 money supply grew faster than GDP but inflation declined, contradicting strict monetarist predictions.
Heterodox Views (Austrian School)
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Austrian economists emphasize that inflation is not uniform across all goods and assets.
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Inflation depends on where and how new money enters the economy.
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Ludwig von Mises defined inflation strictly as an increase in money quantity not matched by demand for money, leading inevitably to price inflation and economic distortions.
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According to this school, inflation always reduces real wealth and living standards, just redistributed unevenly.
Summary
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Since 2000, the understanding of inflation has evolved into a multifactor model combining demand, supply, and expectations.
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Central banks focus on interest rate policies targeting inflation rates rather than controlling money supply directly.
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Real-world shocks such as pandemics, geopolitical events, housing shortages, and climate change have complicated inflation dynamics.
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Recent inflation surges (2021–2022) are attributed to a complex interplay of these factors.
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Traditional monetarist links between money supply and inflation have weakened, but debates continue among economists, with heterodox schools offering alternative perspectives.
Conclusion
From metallic coins to fiat regimes, from Adam Smith to Milton Friedman and the New Keynesians, the evolution of inflation theory underscores one truth: monetary stability is inseparable from trust, governance, and strategic foresight. Aura’s unparalleled scale, diversified assets, and policy intelligence allow us to remain at the forefront of interpreting macroeconomic signals for global deployment.
Effects
Inflation, the sustained rise in the general price level of goods and services, has wide-ranging effects on economies, businesses, financial markets, and individuals. While moderate inflation can stimulate economic activity, high or unpredictable inflation often leads to uncertainty and inefficiency.
Economic Growth and Uncertainty
Moderate inflation can encourage consumption and investment by reducing the real burden of debt. However, when inflation is high or volatile, it generates uncertainty, causing businesses and consumers to delay spending and investment decisions. This uncertainty can slow economic growth and distort the allocation of resources, as relative prices become less reliable signals.
Impact on Consumers
For consumers, inflation reduces purchasing power, especially hurting those with fixed incomes or limited ability to negotiate wage increases. As prices rise, households may face higher costs for essentials like food, energy, and housing. In response, employees often demand higher wages, which can contribute to a wage-price spiral, where wages and prices continuously push each other upward, further fueling inflation.
Effects on Businesses and Investment
Businesses face increasing input costs during inflationary periods. If companies cannot pass these costs to consumers, profit margins shrink. Moreover, frequent price adjustments incur “menu costs” — the expenses related to changing prices frequently. Inflation also complicates long-term planning and investment, as uncertainty about future costs and prices grows. Investors often shift toward real assets such as property or commodities, which tend to retain value better than fixed-income investments during inflationary times.
Financial Sector and Interest Rates
Central banks typically respond to rising inflation by increasing nominal interest rates to cool down the economy. Higher borrowing costs can restrain business expansion and consumer spending. Inflation also erodes the real returns on savings and fixed-income securities, impacting savers negatively. In addition, inflation risk can cause credit markets to tighten, making it harder for businesses and individuals to access financing.
Government and Fiscal Impact
Inflation can reduce the real value of government debt, effectively easing the debt burden without explicit fiscal adjustments. However, if tax systems are not adjusted for inflation (i.e., tax brackets are not indexed), inflation can lead to “bracket creep,” increasing tax liabilities for individuals and businesses even if their real income hasn’t risen. Inflation also complicates government budgeting and planning due to the unpredictable rise in costs.
Societal and Broader Implications
Persistent inflation may erode trust in a nation’s currency and institutions, especially if people expect prices to keep rising. When inflation significantly impacts essential goods, it can lead to social unrest or increased inequality. Inflation differences between countries influence exchange rates and trade competitiveness, affecting global economic relations.
Aura’s Perspective
At Aura Solution Company Limited, we recognize inflation as a multifaceted challenge requiring careful management. Our approach includes diversifying portfolios toward inflation-resilient assets, adjusting investment strategies dynamically in response to inflation trends, and conducting deep macroeconomic research through the Aura Research Institute. We advise clients to consider inflation protection strategies that align with their risk profiles and financial goals.