Economic theory states something about supply and demand. If there is more money around, prices will rise to meet the amount of money available. Why? Simple. If people have money, they are willing to bid up prices. It is as simple as that. So "excess money"., or freely available loan capital or high wages lead to high prices. If money is saved, then theoretically it does not add to price spirals. Theoretically at first. But people put that money in banks. When banks have capital they don't just pay interest on it, they loan it out immediately. Otherwise they are losing money. So more money, much more money, i.e. easy credit, enters the marketplace. It results in more production, so prices may fall, but not until they have eaten up much of the bidding or excess money that is out there.
That is the way it works.
The economy of many countries was based on the worth of silver and gold coinage, which was seen as having intrinsic value. Thus inflation was impossible. England went by silver for ages. The economy of Spain was based on having a ready supply of cheap gold, or money. Some industry represented that money, so at the end of the day it almost balanced out. But ever after Spain had a ruined economy when the money supply collapsed. Yes most of that gold was 'saved'. But it still inflated the economy. I leave it as an exercise for the student to elucidate why this is.
It is very, very simple. Figure it out with very basic thought experiments. Put a bunch of people in one room and give them monopoly money and people in the next room who supply widgets, basic needs and lodging etc. they give out chits which they put in hours for and sell these chits to the people in the consumption room. Give the people in the consumption room, (who are presumed to do nothing except buy stuff), more chits per unit time. What happens to the prices for needs and luxuries set by the people in the production room? What will happen is the demand for luxuries goes up at first. At first the people in the production room are busier, and work longer hours as they get more pay as demand goes up. Prices rise for everything as there is only so much labour and their is lots of money. Then they demand more pay for the same work. The get territorial about their jobs. (Unionism). If you reduce the chit payment for the consumption group the demands for equal payment to the good time level increases, as the people realize if they organize they control wages, prices and work levels. This cuts into the total money available as costs rise for production. The rise and fall of prices demanded and offered are directly related to production and the amount of chits available. It is simple human nature and supply and demand.
Go back to basic supply demand curves and it will become obvious. The invisible hand is the money supply rising and falling. what it does to the supply demand curve is shift it to the right or left.
Now as we go to the right down the curve or declining line, we see P gets lesser, or price falls as Q gets greater. The Q, or quantity demanded increases as Price falls. You would buy more of a thing as the price falls. Generally. Sometimes it can be the other way around for limited markets, in special circumstance, but in general demand rises as price falls.
Now we introduce more money into the equation. What happens? Well people can afford higher prices, so that is where they go. The invisible hand shifts the whole "curve" right. (The curve is represented here by a declining straight line in the graph.) If the money supply falls, then salaries are lower, demand is lower, so prices have to fall. Hence the left shift of the curve. Q stays the same, P goes up and down.
Savings, subsidies, taxes all change the position of the declining SD curve. Tell me how. Taxes reduce money supply. Subsidies increase it within a narrow window, but the subsidies come from taxes. Savings decrease it.
P
| \ <---\|-----------------------money supply gets falls
| \ \
| \ |\
| \ | \
| \ | \
| \ | \<--------money supply gets greater.
| \| \
|______ _\_____\________Q
Q = quantity demanded
P = Price
EC<:-} |
