More money in circulation doesn't mean instant inflation. Sticky input prices, like slow-to-rise wages and rents, create a time lag. Prices adjust gradually, delaying the full impact of increased money supply. Understanding this lag is key to interpreting economic changes.
An increase in the money supply in an economy doesn't instantly lead to price adjustments, and the time it takes for prices to respond is affected by the relative stickiness of input prices. Here's a breakdown of the key points:
Impact of increased money supply:
- Increased liquidity: When more money enters the economy, it circulates, potentially leading to increased spending and demand for goods and services.
- Potential for inflation: If the increase in money supply outpaces the available supply of goods and services, it can eventually lead to inflation, meaning prices rise.
Time lag and sticky input prices:
- Time lag: Inflation doesn't always happen immediately after an increase in money supply. There's a time lag between the two, during which prices may take some time to adjust.
- Sticky input prices: Some costs for businesses, like wages, rents, and raw materials, don't adjust quickly. They are "sticky" because they may be fixed in contracts or take time to renegotiate.
- Delayed price adjustments: As a result of sticky input prices, businesses may initially absorb the increased costs associated with higher demand rather than immediately raising prices. This delay in price adjustments creates the time lag in the inflationary response.
Factors influencing the time lag:
- Degree of price flexibility: Industries with more flexible pricing, like retail, may adjust prices faster than those with rigid pricing structures, like utilities.
- Inflation expectations: If people anticipate future inflation, they may act quickly and spend the additional money, leading to faster price adjustments.
- Monetary policy: Central banks' actions can influence the speed of price adjustments through measures like open market operations and interest rate manipulation.
Overall, understanding the concept of sticky input prices and the time lag in price adjustments is crucial for interpreting the potential consequences of changes in the money supply on an economy.
Q- Suppose there is an increase in the supply of money in an economy. Since input prices are relatively, it can take some time for prices to adjust.