Inflation

Irving Fisher · 1911 / Milton Friedman · 1963 · Wikipedia: Inflation

Inflation is a sustained increase in the general price level. The quantity theory of money (MV = PQ) says prices rise when money supply grows faster than output. Demand-pull inflation comes from too much spending. Cost-push comes from rising input costs. The Fisher effect links nominal interest rates to inflation expectations.

Quantity theory of money: MV = PQ

The equation of exchange: Money supply (M) times velocity (V, how often each dollar is spent) equals the price level (P) times real output (Q). If V and Q are roughly constant, then increasing M proportionally increases P. "Inflation is always and everywhere a monetary phenomenon" (Friedman).

Scheme

; Quantity theory of money: MV = PQ
; If V and Q constant, doubling M doubles P

(define V 5)   ; velocity (constant)
(define Q 100) ; real output (constant)

(define (price-level M) (/ (* M V) Q))

(display "MV = PQ, with V=5, Q=100") (newline) (newline)

(for-each
  (lambda (M)
    (display "  M=$") (display M)
    (display " -> P=") (display (exact->inexact (price-level M)))
    (newline))
  '(100 200 400 800 1600))

(newline)
(display "Double the money, double the prices.")
(newline)
(display "Real output unchanged. Only prices adjust.")

Demand-pull vs cost-push

Demand-pull: too much money chasing too few goods. Government stimulus, credit expansion, or consumer confidence boosts spending beyond capacity. Cost-push: rising input costs (oil shocks, wage spirals) force firms to raise prices even without excess demand. Both produce inflation, but the policy response differs.

Scheme

; Demand-pull: excess spending raises prices
; Cost-push: rising costs raise prices

(define capacity 100)

; Demand-pull scenario
(define (demand-pull-price spending)
  (if (> spending capacity)
      (+ 1.0 (* 0.02 (- spending capacity)))  ; prices rise
      1.0))

(display "Demand-pull inflation:") (newline)
(for-each
  (lambda (s)
    (display "  Spending=") (display s)
    (display ", Price level=")
    (display (exact->inexact (demand-pull-price s)))
    (newline))
  '(80 100 110 120 150))

(newline)

; Cost-push scenario
(define base-cost 10)
(define markup 1.3)

(define (cost-push-price input-cost)
  (* input-cost markup))

(display "Cost-push inflation (30% markup):") (newline)
(for-each
  (lambda (c)
    (display "  Input cost=$") (display c)
    (display ", Price=$")
    (display (exact->inexact (cost-push-price c)))
    (newline))
  '(10 12 15 20 30))

Fisher effect

Irving Fisher's insight: the nominal interest rate equals the real interest rate plus expected inflation. If inflation is expected to be 5%, lenders demand 5% more to preserve real returns. The real rate is set by the supply and demand for loanable funds; the nominal rate adjusts one-for-one with inflation expectations.

Scheme

; Fisher equation: i = r + expected inflation
; i = nominal rate, r = real rate

(define real-rate 0.03)  ; 3% real

(display "Fisher effect: nominal = real + expected inflation")
(newline) (newline)

(for-each
  (lambda (pi)
    (let ((nominal (+ real-rate pi)))
      (display "  Expected inflation=")
      (display (exact->inexact (* pi 100))) (display "%")
      (display " -> Nominal rate=")
      (display (exact->inexact (* nominal 100))) (display "%")
      (newline)))
  '(0.0 0.02 0.05 0.10 0.20))

(newline)
(display "Real purchasing power preserved regardless of inflation")
(newline)
(display "(if expectations are correct)")

Hyperinflation

When governments print money to cover deficits, inflation can spiral. Velocity increases as people spend money immediately, reinforcing the price rise. Historical examples: Weimar Germany (1923, prices doubled every few days), Zimbabwe (2008, monthly inflation of 79.6 billion percent), Venezuela (2018, annual rate above one million percent).

Scheme

; Hyperinflation: compounding monthly inflation

(define (hyperinflate monthly-rate months)
  (let loop ((m 0) (price 1.0))
    (if (= m months) price
        (loop (+ m 1) (* price (+ 1 monthly-rate))))))

(display "Starting price: $1.00") (newline) (newline)

; Moderate: 2% monthly
(display "2% monthly (moderate):") (newline)
(display "  After 12 months: $")
(display (exact->inexact (hyperinflate 0.02 12))) (newline)

; High: 50% monthly (Cagan's threshold for hyperinflation)
(display "50% monthly (hyperinflation):") (newline)
(display "  After 12 months: $")
(display (exact->inexact (hyperinflate 0.50 12))) (newline)

; Extreme: 300% monthly (Zimbabwe-like)
(display "300% monthly (extreme):") (newline)
(display "  After 12 months: $")
(display (exact->inexact (hyperinflate 3.00 12))) (newline)

(display "Hyperinflation destroys money as a store of value")

Key concepts

Concept	Definition
MV = PQ	Money times velocity equals price times output
Demand-pull	Inflation from excess aggregate demand
Cost-push	Inflation from rising production costs
Fisher effect	Nominal rate = real rate + expected inflation
Hyperinflation	Monthly inflation exceeding 50% (Cagan's definition)

Neighbors

Foundations (Wikipedia)

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