Money Supply and Inflation are intrinsically connected. Inflation is a persistent, substantial and continuous increase in the general price level. It is a devaluing of the worth of money often due to an increase in the supply of money. Inflation is a situation of increase in the volume of supply of money and bank credit relative to available goods. This results in a rise of price of goods and factors of production.
Modern economists explain inflation in terms of the aggregate income and expenditure in relation to the aggregate volume of goods and services. Increased money supply leads to higher spending, which in turn causes the price to rise. Keynes' opinion in this matter was that an increase in the supply of money does not necessarily cause an increase in price so long there are unemployed resources. Once the stage of full employment is achieved, an increase in money supply and a consequent increase in the effective demand would cause the price to rise persistently. Inflation can also occur even before full employment when the output of goods and services cannot be increased owing to scarcity of resources or bottlenecks in the supply of some factors. This is called semi inflation or demand shift inflation.
Excessive money supply growth is certainly a major cause of inflation. The monetarist economists like Milton Friedman have put forward their arguments in favor of such a view. This theory has its base in the Quantity Theory of Money, which suggests that if the amount of money in the economy grows faster than the growth in the potential level of output, then this will have its effect on prices. Money supply, if it grows too fast, will obviously lead to inflation.
Demand-Pull inflation is the result of "too much money chasing too few goods." the output also logically increases as a result of the rise in demand, but the supply cannot grow as fast as the demand prices move up. To control this, the economy must grow at a steady pace and there must not be excessive money supply. Cost-Push inflation is caused when the firms' costs go up. This instigates the firms to up the prices of their goods and services. This leads to inflation as well. Increase of wages in a firm due to increased availability of money causes inflation. Increase in taxes and interest rates also results in inflation.
Thus, it might be stated that money supply and inflation are two major factors that play a crucial role in influencing domestic as well as global economy. An increase in money supply causes an increase in inflation.