What Really Causes Inflation?

Mainstream economics typically attributes inflation to either demand-pull factors (too much money chasing too few goods) or cost-push factors (rising input costs like wages or commodities). The dominant monetarist view, popularized by Milton Friedman, holds that 'inflation is always and everywhere a monetary phenomenon' caused by excessive money supply growth. New Keynesian models focus on expectations and sticky prices, while supply-side economists emphasize production bottlenecks. Most mainstream approaches see inflation as primarily driven by monetary expansion that outpaces economic growth, leading central banks to raise interest rates to cool demand and bring inflation under control.

MMT shows that inflation is fundamentally about resource constraints and power dynamics, not money supply. As Warren Mosler explains, inflation occurs when government spending (or private credit creation) attempts to purchase more real resources than are available at current prices, forcing prices higher as different sectors compete for limited capacity. The key insight is that inflation is typically 'sectoral' rather than 'general' - it starts in specific markets where demand exceeds supply (like housing, healthcare, or energy) before potentially spreading. Bill Mitchell and L. Randall Wray emphasize that the currency issuer can always afford to buy whatever is for sale in its own currency, but cannot create real resources. Therefore, the binding constraint is productive capacity, not financial capacity.

Stephanie Kelton and other MMT scholars highlight how inflation often stems from supply-side disruptions, monopoly pricing power, or speculation rather than government deficits per se. The sectoral balances approach shows that persistent government deficits are often necessary to accommodate private sector saving desires - cutting deficits during inflation may actually worsen supply constraints by reducing the resources available for public investment in productive capacity. MMT advocates for targeted interventions like strategic reserves, price controls on essential goods, and public investment to expand supply rather than relying solely on demand destruction through high interest rates.