This unfavorable inflationary trend was reversed in most industrial nations during the mid-1980s. Austere government fiscal and monetary policies begun in the early part of the decade combined with sharp declines in world oil and commodity prices to return the average inflation rate to about 4 percent. Causes Demand-pull inflation occurs when aggregate demand exceeds existing supplies, forcing price increases and pulling up wages, materials, and operating and financing costs. Cost-push inflation occurs when prices rise to cover total expenses and preserve profit margins. A pervasive cost-price spiral eventually develops as groups and institutions respond to each new round of increases.
Deflation occurs when the spiral effects are reversed.
Monetarists believe that changes in price levels reflect fluctuating volumes of money available, usually defined as currency and demand deposits. They argue that, to create stable prices, the money supply should increase at a stable rate commensurate with the economy's real output capacity. Critics of this theory claim that changes in the money supply are a response to, rather than the cause of, price-level adjustments. The aggregate level of income theory is based on the work of the British economist John Maynard Keynes, published during the 1930s. The money supply, then, should be adjusted to finance the desired level of economic growth while avoiding financial crises and high interest rates that discourage consumption and investment.