I'm in the process of writing a guide to UK monetary policy, and thought I'd take a look at the material the Bank provide for participants of their Target 2.0 competition. In it's explanation of the cause of inflation, it says,
But what happens if there is an increase in demand for some reason, for example due to a reduction in income tax, or because consumers suddenly feel more optimistic and start spending more money rather than saving?
• Consumers’ expenditure – spending on goods and services by households in the United Kingdom;
• Capital expenditure – investment in buildings and new equipment;
• Expenditure on stocks of goods – spending by firms on increasing their inventories of goods and materials;
• Government expenditure – spending by central and local government on health, education and other public services;
• Expenditure on exports – spending by foreigners on UK goods and services; and
• Expenditure on imports – spending by UK residents on foreign goods and services.
The ultimate cause of inflation can really be said to be central banks, like the Bank of England. Their behaviour and actions determine whether inflation is allowed to rise or is kept low – in other words, whether they allow prices to rise unchecked by monetary policy, or whether the central bank seeks to influence the amount of money in the economy.
But what happens if there is an increase in demand because of an increase in the money supply