Is There a Causal Relationship between Money Supply and the Inflation Rate? Thoughts from the Gambia

Abstract

Inflation is a monetary problem in every economy, and as in most of the developing economies, the nature of inflation in the Gambia is not an exception. In most economies, especially the developing economies, if the growth rate of money supply is more than the demand for money, there is high possibility that there will be some significant increase in the prices of goods and services during that particular period. During periods of inflation, some governments use different measures to get rid of the inflation in the economy. In the US, for instance, during the 2008 financial crisis, the prices of goods and services, including wheat increased significantly (Keatinge, 2015). The monetarists were able to assess the causes of the crisis; which were down to the supply shocks in the economy, higher demand for food items, increase in the supply of money, increase in the prices of Hard Red wheat, and a huge change in the climate and natural resources (ibid).Economists, however distinguish between two types of inflation: Demand-Pull Inflation and Cost-Push Inflation 1 . Both types of inflation cause an increase in the overall prices of goods and services within an economy.Demand-pull inflation occurs when aggregate demand for goods and services in an economy rises more rapidly than an economy's productive capacity. One potential shock to aggregate demand might come from a country's central bank that rapidly increases the supply of money.On the other hand, cost-push inflation, occurs when prices of production inputs increase. Rapid wage increases or rising raw material prices are common causes of this type of inflation. The sharp rise in the price of imported oil following the OPEC oil embargo in the 1970s, when inflation-adjusted oil prices went up from $25.97 per barrel in 1973 to $46.35 per barrel in 1974, is a classic example of cost-push inflation 2 .