- Government debt, increasing money supply
- Excessive public spending
- Shortages due to trade restrictions
In economics, changes in price levels are called inflation. During the 21st century, virtually all western countries have had a much lower rate of inflation, i.e. price increase, than we have had historically. One reason may be that economists now understand inflation quite well, compared to a few decades ago. Milton Friedman won the Nobel Prize in economics for his work on monetary effects in the 1970s, during a period when many countries struggled with addressing huge inflation problems back then.
A conventional theory explaining how price levels change over time is the Quantity Theory of Money. The idea is that money is to be treated as any other good, where we have a demand and supply of money. The theory straight forward says that if the supply of money increases, prices will increase. The conventional understanding is that inflation is affected by a time lag of about 1,5 years. The following graphs show how the supply of the US Dollar and the Euro has developed recently compared to inflation data.
US Dollar
Government debt
Money supply
Inflation
Euro
Government debt
Money supply
Inflation
Both the US Dollar and Euro, and basically any currency you can come up with, have developed almost exactly as predicted. In 2020, the US and Euro area governments spent huge amounts of borrowed money, increasing the money supply and causing inflation problems to start across the world a year and a half later.
Government spending must be regarded as the main reason for the recent price increases. However, shortages of energy and other raw materials due to military and political conflicts across the world also cause temporary increases in the price of certain goods. Together, these effects have caused major inflation problems in countries all over the world. The reason the United Kingdom’s former prime minister Liz Truss got criticized to the where point she had to leave her role is that she was expected to increase the government deficits during a time of already high inflation, which would not have been wise.
My analysis is that the Federal Reserve in the United States and the European Central Bank overall are doing a decent job in addressing the inflation problems. It is a hard task and takes time, but I think inflation is understood well enough today that we have the tools to solve this problem during 2023, assuming there will not be additional spending and borrowing from national governments.