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One of the factors that supply side economists say was instrumental in ending the US experience of high inflation was the economic expansion of the 1980s ushered in by lower taxes. The argument is that an expanding economy creates an increased demand for base money and in so doing it counteracts inflation forces. An expanding economy can be seen as frequently leading to an increased demand for money and all else being equal an improvement in the value of money. In international currency markets such a principle is reasonably undisputed however supply side economists argue that economic expansion increases the domestic valuation of money and not just the international valuation.
According to the adherents of "growth oriented" theories of the economy - which include both conservative supply-side economists and many neo-Keynesians - inflation is caused by misallocated demand. For the supply-side theorist, this means too much government demand, and the solution to inflation is to lower marginal tax rates on investment. To the neo-Keynesian, this means that goods are mispriced, and supply shocks result when externalities which have accumulated over time are suddenly priced into a good, for example, when pollution in an area starts to cause noticeable illnesses that must be treated, and the pollution cleaned up. To them the solution is to correctly price goods, which will reshape demand away from the over-consumption of seemingly cheap, but in reality expensive, resources.
If you look at the statistical evidence, the relationship between monetary growth and inflation is very weak. Instead, reality indicates that inflation is primarily the result of growth in unproductive forms of government spending (basically entitlements and other expenditures that fail to stimulate the supply side). The evidence both from the U.S. and other countries clearly demonstrates this relationship.
Rapid inflation is always and everywhere produced by excessive creation of government liabilities without a corresponding increase in the amount of goods produced by the economy. (Compare with Milton Friedman, "inflation is always and everywhere a monetary phenomenon".)
One example being the 1920's German Ruhr valley when the German government paid striking workers using government securities while production was standing still.
The “ monetary exchange equation " (usually written PY = MV) in terms of percentage changes (%P + %Y = %M + %V) rearranged gives %P = %M + %V - %Y. Inflation (%P) is equal to the rate of money growth ( money supply growth) (%M), plus the change in velocity (GDP/ money supply) (%V), minus the rate of output growth ( GDP growth) (%Y). So increasing money supply and increasing "velocity" of money (which is money supply growing faster than GDP (%Y)) drives inflation, while output growth is reducing, not increasing, inflation. Does different types of spending affect inflation differently? Yes, when the spending doesn't stimulate output it creates inflation, be sure to note the "-%Y" at the end of the equation, output absorbes inflation. Productive spending put downward pressure on prices.
"It is patent superstition to believe that the Federal Reserve can control inflation if fiscal policy is out of control." ([3])
The Consumer Price Index basically measures the marginal utility of consumer goods divided by the marginal utility of money: P = MUgoods / MUmoney (MU = marginal utility). Given this, there are exactly four causes for inflation:
In short, we get inflation when:
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