Inflation in the United States Essay Example | Topics and Well Written Essays - 1250 words

Inflation in the United States - Essay Example Inflation in the United States Inflation affects the lives of all citizens in the US economy yet not everyone has the same purchasing power and income. It is therefore important for us to understand the causes of inflation, its effects and some actions taken by the government to regulate it. There has been a wide range of literature on the causes of inflation in history. There are different schools of thought on the causes of inflation. They are commonly divided into quantity theories of inflation and quality theories of inflation (Cate 96). The quantity theory of inflation is based on the quantity of money equation. On the other hand, the quality theory of is based on the sellers expectations to exchange currency at a later date. Presently, the quantity of the theory money theory is widely accepted as the inflation model in the long- run. This paper shall explore the causes of inflation based on three major theories, the Keynesian view, the rational expectations theory and the monetarist theory. The Keynesian vie w asserts that changes in money supply in the economy do not directly affect the prices of goods and services, inflation results from economic pressures that are manifested in the increases prices of goods and services. According to Robert J. Gordon’s triangle model, there are three main types of inflation: demand- pull inflation, monetary expansion and cost-push inflation. (Cate 141). Demand- pull inflation is the most common and it describes a situation where the demand of goods increases over and above the supply. Sellers increase the prices of goods, as they know that they have the liberty to do so. There are numerous circumstances resulting to demand pull inflation the most important being an expanding economy. This type of inflation could lead to economic growth as long as it is within the right limits. Since people expect increasing inflation rates, they make increasing purchases to avoid price increases in future. Cost-push inflation is caused by a drop in the aggrega te supply. This may have been as a result of an increase in the prices of inputs and natural disasters. Finally, built in inflation is caused by adaptive spirals that are relate to shifts in prices or wages. An important concept in this theory is the relationship between unemployment and inflation that is commonly referred to as the Phillips curve (Cate 141). This concept suggests that there is a tradeoff between the stability of prices and employment. This model was used to describe the status of the US economy in the 1960s however; it failed to explain the connection between economic stagnation and increasing inflation. It can be stated that the Philips curve explains the demand- pull aspect of the triangle model. The rational expectations theory states that economic actors act rationally to maximize their well being in future. They do not act solely depending on opportunity cots and pressures. This view states that future expectations and strategies play a key role in inflation ( Gillman 67). A key assumption in this theory is that economic actors will act to keep up with rising inflation rates. This means that the central bank must play a key role in ensuring that they regulate the insurance rates. The monetarist view is based on the fact that the major factor affecting deflation or inflation is the velocity of money. In other words, inflation is affected by how quick the supply of