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A major demand-pull theory centers on the supply of money: inflation may be caused by an increase in the quantity of money in circulation relative to the ability of the economy to supply (its potential output). This has been seen most graphically when governments have financed spending in a crisis by printing money excessively (say, due to war or civil war conditions), often leading to hyperinflation where prices rise at extremely high rates (say, doubling every month).
The money supply is also thought to play a major role in determining levels of more moderate levels of inflation, although there are differences of opinion on how important it is. For example, Monetarist economists believe that the link is very strong; Keynesian economics by contrast typically emphasise the role of aggregate demand in the economy rather than the money supply in determining inflation. That is, for Keynesians, the money supply is only one determinant of aggregate demand.
A fundamental concept in such Keynesian analysis is the relationship between inflation and unemployment, called the Phillips curve. This model suggested that price stability was a trade off against employment. Therefore some level of inflation could be considered desirable in order to minimize unemployment. The Philips curve model described the US experience well in the 1960s, but failed to describe the combination of rising inflation and economic stagnation (sometimes referred to as stagflation) experienced in the 1970s.
Thus, modern macroeconomics describes inflation using a Phillips curve that shifts (so the trade-off between inflation and unemployment changes) due to such matters as supply shocks and inflation becoming built into the normal workings of the economy. The former refers to such events as the oil shocks of the 1970s, while the latter refers to the price/wage spiral and inflationary expectations implying that the economy "normally" suffers from inflation. Thus, the Phillips curve represents only the demand-pull component of the triangle model.
Another Keynesian concept is the potential output (sometimes called the " natural gross domestic product"), a level of GDP where the economy is at its optimal level of production, given institutional and natural constraints. This level of output corresponds to the NAIRU or the "natural" rate of unemployment or the full-employment unemployment rate. In this framework, the built-in inflation rate is determined endogenously (by the normal workings of the economy):
However, one problem with this theory for policy-making purposes is that the exact level of potential output (and of the NAIRU) is generally unknown and tends to change over time. Inflation also seems to act in an asymmetric way, rising more quickly than it falls. Worse, it can change due to policy: for example, high unemployment under Prime Minister Margaret Thatcher in the U.K. may have led to a rise in the NAIRU (and a fall in potential) because many of the unemployed found themselves as structurally unemployed, unable to find jobs that fit their skills in the British economy. A rise in structural unemployment implies that a smaller percentage of the labor force can find jobs at the NAIRU, where the economy avoids crossing the threshold into the realm of accelerating inflation.
Most non-Keynesian theories of inflation can be understood within the neo-Keynesian perspective as assuming that the NAIRU and potential output are both unique and are attained relatively quickly. With the "supply side" at a fixed level, the amount of inflation is then determined by aggregate demand. The fixed supply side also implies that government and private-sector spending are always in conflict, so that government deficit spending leads to crowding out of the private sector and has no effect on the level of employment. Thus, it is only the money supply and monetary policy that determine the inflation rate.
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