Whether an increase in the rate of inflation in the UK always and solely results from an increase in the money supply

Whether an increase in the rate of inflation in the UK always and solely results from an increase in the money supply.            [15]

Like the prices of goods are determined by it supply and demand, the relative price of money is determined by the rate of interest.  Originally the term ‘inflation’ was used to describe increase in money supply, but in modern context it now refers to sustained increase in general pricing level. On the other hand, the money supply is the quantity of money issued by a country’s financial authority.

Assuming that price level do not instantly adjust to equilibrium point, it’s the responsibility of the bank of England that rate of inflation is steady; they have to make sure also that AD matches AS, in order to do so, they control the money supply. More money in circulation may stimulate demand, and vice verse.   If there is a shortfall of AD relative to AS, then the economy will not be operating in full capacity, in this case, the bank may choose to increase money supply. The additional demand tends to increase in employment, and ultimately to inflation. However as economists like Milton Friedman suggested, banks cannot predicate exact optimum money supply, in turn may lead to wider swing in the economy than if the system was left alone; which may or may not result in equal amount of inflation.

As we see, through the monetary exchange equation, the money supply is somewhat linked to inflation:                MV=PQ

Where M is the nation’s money supply, V being the number of time each unit of exchange is used, then P is the average price of all goods and services in specific year, finally Q is the quantity of goods and services sold during the year. So in short, if money supply grows faster than the real GDP, inflation will follow; to prove this theory numerically, as the velocity (V) and transaction (T) are generally assumed to be constant by the monetarists, for the equation to be same on both sides, then increase in money supply on the left hand side will lead to greater rate of inflation on the right hand side.  However in reality, it varies with the stance of external factors, especially relative to business cycle. Now since monetary exchange equation showed how the relationship may exist in theory, I will look in more detail about how the increase in money supply could lead to inflation, in more realistic step by step macroeconomic terms; starting from the supply of money to increased investments, and in turn how inflation may be resulted.

The figure on the right shows the supply and demand of money. The demand curve is called liquidity preference schedule, its down sloped as there is an inverse relationship between rate of interest and quantities of money, given that at the high the rate of interest, firms and households tend to hold non-money assets such as bond or share; whereas supply of money remains constant, and is only changed by the bank of England in the context of UK market.

Within the next graph, one may assume that the central bank increases money supply, as result, there would ...