Monetarist explanation of inflation operates through the Fisher equation.
M.V = P.T
M = Money
Supply V = Velocity of Circulation
P = Price
level T = Transactions or Output
Monetarists assume that V and T are fixed, there is a direct relationship
between the growth of the money supply and inflation. The mechanisms by which
excess money might be translated into inflation are examined below.
can also spend their excess money balances directly on goods and services.
This has a direct impact on inflation by raising aggregate demand. The more
inelastic is aggregate supply in the economy, the greater the impact on
increase in demand for goods and services may cause a rise in imports.
Although this leakage from the domestic economy reduces the money supply, it
also increases the supply of pounds on the foreign exchange market thus
applying downward pressure on the exchange rate. This may cause imported
money balances are spent on goods and services, the increase in the demand
for labour will cause a rise in money wages and unit labour costs. This may
cause cost-push inflation.