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What is the relationship between money supply and inflation? In the economy, inflation and the money supply correlate with each other. The money supply can be defined as notes and coins circulating outside the central bank. Inflation is a sustained rise in prices, which is normally measured by using the Retail Price Index otherwise known as the RPI. As money supply circulating around the economy increases inflation and balance of payments in turn also increases, however, this has very little effect on employment. The increase in money supply can be defined as the direct monetary transmission mechanism, which means that an increase in money supply leads to people spending the excess of their money supply over money demand. When people have more disposable income to spend on luxury goods aggregate demand also increases. Therefore businesses must increase the aggregate supply to give consumers what they want. If the government wants to...

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